Pimco Finds Silver Lining to Canada Gloom in Bond-Market Gains

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Canada’s souring economy is giving the country an edge in the fixed-income market, where it’s beating Group of Seven peers and drawing buyers including Pacific Investment Management Co.

Pimco, which manages about $1.52 trillion, is among investors betting Canadian debt will keep outpacing Treasuries after the Bank of Canada lowered its benchmark rate for the second time this year and ratcheted back growth forecasts.

“We have and will continue to position our portfolios to take advantage of that,” said Pimco’s Ed Devlin, who oversees about $17 billion in New York, including the Canadian Total Return Bond Fund. “We would think the U.S. continues to underperform Canada.”

At about 1.5 percent, Canada’s 10-year yields are about 0.8 percentage point below those on similar-maturity Treasuries, the biggest gap in Bloomberg data going back to 1989. Pimco’s Devlin said the spread may keep widening.

Northern Gulf

The Bank of Canada reduced its benchmark rate to 0.5 percent Wednesday. In congressional testimony Wednesday and Thursday, Federal Reserve Chair Janet Yellen said she expects to lift the U.S. benchmark this year from near zero, where it’s been since 2008. Fed policy makers are scheduled to meet at month-end, as well as in September, October and December.

Canada’s economy is feeling the pain from its dependence on commodities. Crude oil, Canada’s biggest export, has dropped about 50 percent from a year ago, fueling speculation the Bank of Canada isn’t done trimming borrowing costs.

“With oil hovering at a price well below that which would get Canada out of the doldrums, this may not be the last cut,” Luke Bartholomew, a fund manager at Aberdeen Asset Management in London, wrote in a note Wednesday. The firm manages $491 billion. “It highlights the gulf between the U.S. and Canada as the Fed looks to raise rates this year.”

The prospect of the Fed’s first rate increase since 2006 may bolster demand for Canadian bonds, said Pimco’s Devlin.

“The gap could still go wider,” he said. “The trigger would be the U.S. markets selling off in anticipation either of a September or December rate hike.”

2015 Divergence

Investors have earned 2.7 percent in Canadian bonds this year through July , more than every other G-7 peer, according to a Bank of America Merrill Lynch index. Last year, Canada’s debt trailed every G-7 nation except the U.S. and Japan. The group’s other members are France, Germany, Italy and the U.K.

David Wolf, who manages C$50 billion at Fidelity Investments in Toronto, is resisting the Canadian bond rally. He favors U.S. government securities and says Canadian yields have fallen too far.

“You’re already discounting a lot of Canadian economic underperformance,” Wolf said Wednesday.

The rate divergence between Canada and the U.S. is rare. The nations are the world’s largest two-way trading partners, with the U.S. accounting for 75 percent of Canada’s exports.

Gross domestic product probably “contracted modestly” in the first half, the Bank of Canada said Wednesday. A rebound in non-energy exports should keep the economy growing for the full year, according to the bank.

“I wouldn’t be surprised if the Canadian economy turned out to be a little more weak than this forecast,” Alessio de Longis, a money manager in the Global Multi-Asset Group at OppenheimerFunds Inc., said from New York. De Longis, whose firm oversees about $235 billion, sees the Canadian economy expanding by less than 1 percent this year and is betting its currency will decline.

“When your exports are not competitive, even a rebound in the U.S. no longer helps,” he said.

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