Investors Bet on Carney Late-Year Rate Pause: Canada Credit

Bank of Canada Governor Mark Carney won’t stray too far from his Group of Seven peers with interest rate increases this year following tomorrow’s expected move, as investors bet a fourth-quarter pause will limit a rise in short-term bond yields.

The December bankers acceptances futures contract yield was 1.30 percent at 9:15 a.m. New York time, down from 1.61 percent on June 10. The so-called BAX contracts have settled an average of about 20 basis points above the central bank’s overnight target since 1992, Bloomberg data show.

“The bank will have a bit of a pause after we get a couple more rate hikes under the belt,” said Michael Gregory, senior economist at Bank of Montreal in Toronto. “The first part of the curve to see that benefit will be the shorter securities.”

The bank has four rate decisions remaining this year, including tomorrow’s at 9 a.m. New York time. The 20 economists surveyed by Bloomberg unanimously predict Carney will raise the bank’s policy rate for a second straight month by a quarter point to 0.75 percent.

At its June 1 decision, the bank said future increases would weigh progress in the domestic recovery against an uneven global expansion. In the last month, reports have shown economic growth stalled in April and job creation was faster-than-expected in June, while the bank said June 21 that global financial strains have increased since the end of last year.

The benchmark two-year government bond’s yield may remain at about 1.6 percent at the start of the fourth quarter, near the 1.56 percent it traded for at 9:15 a.m. Concern that slower U.S. growth may hurt Canada’s economic recovery will hold Canadian bond yields down as the central bank raises rates, Gregory said.

“Standing on the Sidelines”

Bank of Nova Scotia cut its forecast for the two year bond in the fourth quarter this month, to 1.9 percent from 2.15 percent in June. Carney will be “standing on the sidelines” waiting for the U.S. Federal Reserve to move after increases tomorrow and at the Sept. 8 decision, said Derek Holt, economist at Bank of Nova Scotia in Toronto.

Elsewhere in credit markets, the extra yield investors demand to own Canadian corporate rather than federal government debt narrowed on July 16 to 143 basis points, according to a Bank of America Merrill Lynch index. A basis point is 0.01 percentage point.

The central bank on July 22 will also release a quarterly economic forecast, followed by a press conference with Carney. The Bank of Canada’s April Monetary Policy Report predicted economic growth will slow to an annualized pace of 3.5 percent in the third quarter, from the 6.1 percent rate seen between January and March.

Consumer Inflation

Statistics Canada will probably report July 23 that consumer prices advanced 0.9 percent in June from a year ago, slower than May’s pace of 1.4 percent. Excluding eight volatile items such as gasoline, inflation accelerated to 1.9 percent in June from May’s 1.8 percent, according to a Bloomberg economist survey.

Canada’s rate increase was the G-7’s first since a global recession last year. With economists not expecting the Federal Reserve to raise rates this year, further Canadian increases could slow Canada’s recovery by boosting the country’s dollar and curbing exports, said Peter Dungan, an associate economics professor at the University of Toronto.

“They might do a quarter for the next meeting or two to get it up into the 1 percent range but at that point if there are signs of weakness in the U.S. and the Canadian dollar was flirting at par I think they would put it on hold for a while,” Dungan said.

Inflation won’t “back up” bond yields, said Mark Carpani, senior vice president at Ridgewood Capital Asset Management in Toronto. “I don’t think there’s a lot of risk of them ratcheting up much higher” because of inflation or the central bank, he said.

Two-year bonds still won’t offer the best protection against rising interest rates, Carpani said. “The mid-to-long end of the curve represents the best value,” he said.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE