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Trading Patterns Show ‘Damaged’ Bond Market: Canada Credit

Royal Bank of Canada Headquarters in Toronto
Moody’s Investors Service downgraded Royal Bank of Canada’s credit rating for the first time in at least 15 years to Aa1 from Aaa because of the lender’s increased focus on investment banking and trading. Photographer: Norm Betts/Bloomberg

Canadian government bond yields are rising past long-term barriers, indicating further losses may be in store as investors favor stocks amid U.S. stimulus measures, trading patterns show.

Canada’s five-year bond yield closed above its 200-day moving average last week and 10-year bonds lost their yield advantage over equivalent-maturity U.S. securities for the first time since May. The 5-, 10- and 30-year yields are straining at so-called Fibonacci levels, according to Royal Bank of Canada and Canadian Imperial Bank of Commerce.

“From a technical-analysis perspective, the bond market has undergone significant damage,” said Mohammed Ahmed, a rates strategist at CIBC World Markets in Toronto. There’s a “visible rotation out of bonds and into stocks,” he said.

Investors are dumping North American bonds, reversing the buying frenzy that led up to the Federal Reserve’s Nov. 3 announcement that it would buy U.S. bonds in a policy known as quantitative easing. The sell-off accelerated last week on President Barack Obama’s plan to extend Bush-era tax cuts.

Canadian 10-year yields gained 56 basis points to 3.37 percent today, from 2.81 percent on Nov. 4, the day after the Fed unveiled plans to buy $600 billion in Treasuries through June to spur economic growth. The yields are rising so fast they exceed all 18 of the March 2011 forecasts of economists in a Bloomberg survey. The highest, from Kurt Karl, Swiss Re’s chief U.S. economist, calls for yields at 3.2 percent by then. The weighted average estimate is 2.95 percent.

Fibonacci Analysis

Ten-year yields touched 3.347 percent yesterday, topping 3.341 percent, which represents the 61.8 percent Fibonacci retracement from the April 20 high. Fibonacci analysis, modeled on patterns that appear in nature, is based on the theory that prices rise or fall by certain percentages after reaching a high or low. It was developed by a 13th century mathematician, Leonardo da Pisa, known as Fibonacci, who discovered the sequence while studying the reproduction rate of rabbits.

Elsewhere in credit markets, Genworth MI Canada sold C$150 million ($149 million) in 4.59 percent bonds maturing in December 2015, Manulife Financial Corp.’s credit ratings were cut by Standard & Poor’s and Royal Bank of Canada was lowered by Moody’s Investors Service.

The extra yield investors demand to own the debt of Canadian corporations rather than the federal government remained yesterday at 142 basis points, or 1.42 percentage points, unchanged from Dec. 10, according to a Bank of America Merrill Lynch index. Corporate bonds are up 6.2 percent this year, compared with 8.7 percent for U.S. corporate bonds and 6.7 percent for global corporates.

RBC Downgrade

Moody’s Investors Service downgraded Royal Bank of Canada’s credit rating for the first time in at least 15 years to Aa1, the second-highest rating, from Aaa because of the lender’s increased focus on investment banking and trading. Moody’s downgrade brings it more in line with S&P’s, which rates the bank AA-, its fourth-highest grade.

Manulife Financial Corp., the country’s biggest insurer, had its rating cut to A- by S&P, which cited weak U.S. earnings.

In provincial bond markets, relative yields tightened to 53 basis points, from 54 at the end of last week, as yields fell to 3.29 percent, according to Merrill Lynch data. The 397 bonds with a par value of C$468 billion have advanced 5.9 percent this year, after gains of 3.7 percent and 6.8 percent in the previous two years.

Government bonds are down 0.8 percent this month, trimming the 2010 advance to 5.3 percent. That compares with a gain of 5.6 percent this year for Treasuries. Global sovereign bonds are 3.3 percent higher this year.

Debt Auction

Canada will auction tomorrow C$3 billion of 1.75 percent notes maturing in March 2013. The previous government sale of two-year bonds, on Nov. 10, drew an average yield of 1.56 percent and a bid-to-cover ratio of 2.45 times, according to data on the Bank of Canada’s Web site.

Royal Bank raised its five-year mortgage rate 20 basis points to 4.24 percent yesterday, reflecting rising bond yields.

Bank of Canada Governor Mark Carney said the refusal by some countries to let their exchange rates float is slowing inflation in advanced economies, which may spark additional loosening of policies globally.

Keeping currencies fixed has begun to force inflation higher in emerging markets and disinflation elsewhere, which “reinforces the low-interest-rate strategies of major advanced economies and may necessitate further rounds of quantitative easing,” Carney, 45, said in the text of a speech he gave in Toronto yesterday.

Household Debt

Canadian households posted higher debt ratios than their U.S. counterparts for the first time in 12 years. The ratio of household credit market debt-to-personal disposable income rose to 148.1 percent from 143.4 percent as income fell 1.5 percent, Statistics Canada said in a report from Ottawa. U.S. debts represent 147.2 percent of households’ disposable income, according to the U.S. central bank.

Canada’s index of leading economic indicators rose 0.3 percent in November, the second straight gain, led by increases in housing and stock prices, the statistics agency said. Economists surveyed by Bloomberg News predicted the index would rise 0.5 percent, based on the median of nine estimates.

“Chatter surrounds two key technical points in Canada’s bond market,” Mark Chandler, head of Canadian currency and fixed-income strategy at RBC Capital Markets in Toronto, wrote in a note to clients yesterday. He cited the five-year yield breaking its 200-day moving average, and the Canadian and U.S. 10-year yields reaching parity.

Moving Average

“Both of these moves point to some bearish upcoming moves in Canadian fixed-income markets, though we would suggest they are premature,” Chandler said.

The benchmark five-year bond’s yield rose to 2.60 percent today. It closed above the 200-day moving average, a momentum indicator, of 2.465 percent on Dec. 8 for the first time June 16. The 200-day moving average is calculated by adding the closing prices for the last 200 days and dividing by 200. As new prices are added, older prices drop off.

Yields on 10-year U.S. government bonds exceeded their Canadian equivalent by 10 basis points today, the most since April 26. They last converged in May. The U.S. 10-year yield has increased 55 basis points to 3.47 percent since Obama and congressional Republicans agreed last week to extend Bush-era tax cuts, including cuts for the wealthy.

Stocks, Fed

Thirty-year Canada yields rose as high as 3.772 percent today, piercing 3.744 percent, which is the 50 percent Fibonacci retracement level from the high this year on Jan. 7. Traders use Fibonacci levels to establish targets once a so-called trend reversal occurs.

The S&P/TSX Composite Index, Canada’s primary stock gauge, is up 4.6 percent since Nov. 2, the day before Fed Chairman Ben S. Bernanke embarked on the latest round of unconventional easing. The S&P 500 Index is up 3.9 percent during that period.

A decrease in trading volume before the Christmas holidays may mean price swings in government securities are exaggerated, according to CIBC’s Ahmed.

“Winter holidays in the coming weeks are likely to contribute to illiquidity and exacerbate moves in an already weak market,” the strategist wrote.

The Fed stuck with its plan to buy $600 billion of Treasuries through June amid criticism from top Republican lawmakers. The purchases will “promote a stronger pace of economic recovery” and keep prices stable “over time,” the Federal Open Market Committee said today in a statement in Washington. It added that unemployment is too high, and repeated a pledge to leave the benchmark interest rate low for an “extended period.” The rate has been a range of zero to 0.25 percent since December 2008.

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