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Sovereign Returns Trail Peers By Most Since July: Canada Credit

Bank of Canada Governor Mark Carney
Speculation that Bank of Canada Governor Mark Carney may raise borrowing costs next quarter to cool inflation is driving domestic yields higher. Photographer: Tomohiro Ohsumi/Bloomberg

Canada’s government bond returns are lagging behind the rest of the world this month for the first time since July as investors bet the nation’s central bank may increase interest rates sooner than analysts expected.

The Bank of America Merrill Lynch Canadian Government Bond Index, with 30 bonds and a par value of C$317 billion ($311 billion), lost 1.37 percent this month through Nov. 26, compared with declines of 1.36 percent on Merrill’s index of global sovereign bonds.

Bond prices are falling as domestic and international indicators signal an accelerating economic recovery, even as political unrest on the Korean peninsula and debt woes in Europe drive risk aversion higher. Speculation that Bank of Canada Governor Mark Carney may raise borrowing costs next quarter to cool inflation is driving domestic yields higher.

“The market seems to be thinking that the Bank of Canada may hike rates sooner than what is priced into the curve,” George Davis, chief technical analyst in Toronto at Royal Bank of Canada’s RBC Capital unit, wrote in an e-mail. “The repricing of this view has caused Canadian rates to back up,” he said, referring to rising bond yields.

Davis said he doesn’t expect Carney to raise rates until April, meaning the sell-off in Canadian government bonds may be overdone. He predicts two-year yields will “correct” to 1.55 percent to 1.6 percent, from 1.67 percent on Nov. 26.

Bank on Hold

“Yields in Canada are back to the cheaper end of the range now,” Roger Quick, a fixed-income analyst with Bank of Nova Scotia’s Scotia Capital unit, said by phone from Toronto. “If the Bank of Canada is on hold for a long time, and we think they’re on hold until September, 70 basis points over the overnight target is pretty good.”

Canada’s government debt outperformed the global index by 1.1 percentage points this year through October.

Elsewhere in credit markets, the extra yield investors demand to hold the debt of Canada’s corporations rather than its federal government widened to 136 basis points, or 1.36 percentage points, from 135 basis points at the end of the previous week, according to Bank of America Merrill Lynch data. Spreads reached 134 basis points Nov. 16, the narrowest gap since May. Corporate yields were unchanged at 3.86 percent Nov. 26, from 3.86 percent a week earlier.

Relative yields on U.S. corporate bonds ended last week at 176 basis points, from 175 basis points the week before, the Bank of America Merrill Lynch data showed. Global corporate spreads were 170 basis points, widening from 165 on Nov. 19.

Canadian corporate bonds are down 0.9 percent in November, poised for the worst month this year. U.S. company debt has lost 1 percent in the month through Nov. 25. Global corporates are down 1.2 percent.

Provincial Debt

In provincial bond markets, relative yields widened to 54 basis points, from 52 a week earlier. They reached 51 basis points on Nov. 16, the tightest spreads since April, from as wide as 71 basis points on May 21. Yields fell to 3.23 percent on Nov. 26 from 3.24 percent the week before.

Provincial bonds have lost 2.1 percent this month, the biggest loss since September 2008.

Ontario, Canada’s largest province, sold C$50 million of floating-rate notes due in October 2015. The notes pay 23 basis points over the quarterly Canadian Dealer Offered Rate. The issue brings the total outstanding to C$516 million.

The yield on benchmark 10-year government bonds dropped 6 basis points to 3.11 percent, as the price of the 3.5 percent security due in June 2020 dropped 50 cents to C$103.21.

Not Happening

The prospect of earlier Bank of Canada rate increases is “off the wall,” Carlos Leitao, chief economist with Laurentian Bank Securities in Montreal, said in a phone interview. “That is just not going to happen.”

Canada’s current account deficit widened to a record in the third quarter, led by higher machinery and equipment imports and a decline in exports, Statistics Canada said today in Ottawa.

Payments sent abroad exceeded receipts from outside Canada by C$17.5 billion ($17.2 billion) in the July-September period. The figure exceeded all 16 predictions in a Bloomberg News survey that had a median deficit of C$15.3 billion.

The slow pace of the U.S. recovery means Canadian exports to its southern neighbor and largest trading partner will not increase as much as some analysts expect. Inflation will remain subdued and the Bank of Canada will not raise interest rates in the near term, Leitao said.

Inflation Rate

Even so, reports last week showed Americans increased spending for a fifth month in October and filed the fewest unemployment claims in more than two years. Statistics Canada reported that inflation increased to 2.4 percent in October from 1.9 percent in the prior month, faster than all 23 economists in a Bloomberg survey predicted.

Analysts at Morgan Stanley and Bank of America Corp. last week predicted the Bank of Canada will begin raising interest rates as early as January.

“I’ve been calling for them to raise rates in January,” Sheryl King, head of Canada economics at Bank of America, said in a Nov. 23 phone interview. The most recent Canadian inflation data “probably seems like something that will prompt them to move.”

Carney left rates unchanged at 1 percent in October after three successive quarter-point increases starting in June. The next rates announcement is on Dec. 7, followed by Jan. 18.

Leitao pinned falling bonds prices on investors’ bets that the Canadian economy is strong enough to require rate increases. He predicts Statistics Canada will announce third-quarter output growth of 1.5 percent tomorrow, matching the median forecast in a Bloomberg survey of 20 economists.

Quantitative Easing

On Nov. 3, the Federal Reserve unveiled plans to buy $600 billion of Treasury securities through June in a bid to reduce unemployment and keep the inflation rate from falling further in a second round of so-called quantitative easing.

“Part of the backup in yields is the recognition that, given all the criticism, the Fed may be done with quantitative easing,” Avery Shenfeld, chief economist at CIBC World Markets in Toronto, said in a telephone interview. “The broader direction for yields over the next year will be higher in both the U.S. and Canada.”

Leitao disagrees, saying a “significant” bond rally will start by Christmas and intensify next year, as Europe’s debt crisis creates a haven bid for Canadian assets, given the country’s relatively sound fiscal and economic fundamentals.

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