Carney Watching U.S. Means October Rate Boost Odds Diminish: Canada Credit
Chances that Bank of Canada Governor Mark Carney will raise interest rates next month are heading toward zero amid signs the slowdown in the U.S. economy is hampering the Canadian recovery.
Probabilities of a quarter percentage-point increase at the Oct. 19 central bank meeting stood at 18 percent today, down from 20 percent yesterday and 40 percent two weeks ago, according to Bank of Nova Scotia data derived from overnight index swaps. Bank of Montreal pegged the odds of an October rise at 10 percent to 20 percent. Carney said today that “caution” is warranted in any future increases.
Traders are trimming bets that growth will be strong enough for Carney to raise borrowing costs at a fourth straight meeting because the U.S. economy, consumer of about three-quarters of Canadian exports, remains fragile. The Federal Reserve said last week it’s “prepared to provide additional accommodation” to spur growth. Carney said later in a speech there are “limits” to how far monetary policy in the two countries can diverge.
“The market has totally reversed its view on the Bank of Canada,” Blake Jespersen, a currency strategist at Bank of Montreal’s BMO Capital unit, wrote in an e-mail, referring to an October rate increase. Both Bank of Montreal and Scotia predict less than an even chance for an increase in December.
A government report showing Canada’s economy shrank for the first time in almost a year may make rate increases even less likely. Statistics Canada said today that gross domestic product fell 0.1 percent in July, the first decrease since August 2009, matching the median of 22 forecasts compiled by Bloomberg.
‘Bias Against a Hike’
“This morning’s number will not likely add to any” expectations for an increase, Jack Spitz, managing director of foreign exchange at National Bank of Canada, said by phone from Toronto. “It may even take away from some of the pricing-in that’s already in the market. I see it as confirming the market’s overall bias against a rate hike in October.”
Elsewhere in credit markets, the extra yield investors demand to hold the debt of Canada’s companies instead of its federal government ended yesterday at 144 basis points, according to a Bank of America Merrill Lynch index. The spread has tightened 5 basis points, or 0.05 percentage point, in September and the same amount since June 30. Yields fell to 3.64 percent, unchanged since the end of August and down from 3.95 percent at the end of June.
Global corporate bonds have returned 4 percent so far this quarter, including reinvested interest, compared with 2.96 percent for Canadian corporate debt, according to the Merrill data. For global debt, that would be the best performance since the three months through September 2009.
Royal Bank of Canada, the country’s largest lender by assets, sold $1 billion of 3.25-year U.S. dollar-denominated notes, according to data compiled by Bloomberg. The 1.125 percent notes were priced at 99.853 cents on the dollar to yield 1.171 percent, the data show.
HSBC Bank of Canada paid 126.1 basis points over benchmarks to sell C$1 billion (C$970 million) of 3.56 percent bonds due in October 2017.
In the nation’s provincial bond market, relative yields tightened to 57 basis points yesterday from 60 basis points on Aug. 31 and 64 basis points on June 30. Yields ended yesterday at 2.94 percent, from 2.93 percent at the end of last month. Provincial debt has made investors 0.77 percent this month, extending the gain this quarter to 3.73 percent and the 2010 return to 7.88 percent, already the best annual performance since 2002.
Manitoba paid 84 basis points over benchmarks to sell C$300 million of 4.1 percent bonds due in March 2041, in its first debt sale since July.
Government Debt Spreads
British Columbia’s municipal financing authority, which issues debt on behalf of local governments, sold C$230 million in a reoffering of its 4.45 percent bonds due in June 2020, bringing the issue to C$435 million outstanding. The debt priced to yield 91 basis points over benchmarks.
Government bonds, with about C$326 billion outstanding, have returned 0.26 percent this month, after reinvested interest, the Merrill data show. The index dropped 0.83 percent in March, its last monthly loss. U.S. government bonds are flat this month, compared with a 0.29 percent drop for government bonds worldwide.
Since Carney lifted Canada’s key interest rate by 25 basis points to 1 percent on Sept. 8, a report showed Canada’s unemployment rate increased and measures of inflation and retail sales unexpectedly fell, pointing to a weaker recovery than policy makers predicted.
A Bank of Canada on hold may cut into the yield advantage of Canadian 2-year bonds over their U.S. counterparts. The spread reached 106 basis points last week, the most in more than two months and close to the highest in seven years.
‘Spreads Will Narrow’
“Canada-U.S. spreads will narrow quite a bit,” Carlos Leitao , chief economist at Laurentian Bank Securities in Montreal, said in a telephone interview. He predicts the 2-year yield gap in Canada’s favor will tighten to 75 basis points in the second half of 2011, from 95 basis points today. “If we’re not that much stronger than the U.S. and we don’t require so much higher policy rates, that spread will narrow.”
Every 0.1 percent miss in monthly GDP versus consensus forecasts means shorter-term yields may decrease by 2 to 4 basis points, according to Eric Lascelles, chief economics and rates strategist at Toronto-Dominion Bank’s TD Securities unit.
“The market is so focused on double-dip concerns and the Bank of Canada is very much in play,” Toronto-based Lascelles said in an e-mail.
Probabilities derived from swap rates differ with signals on interest rates from the Taylor rule formula for determining optimal rates, which show the gap in Canadian and U.S. benchmark interest rates is at a 15-year high and borrowing costs are poised to rise further in Canada.
Using the rule formulated Stanford University economist John Taylor, which measures inflation and output to estimate the ideal interest rate, the Bank of Canada’s benchmark should be about 2 percent, 1 percentage point higher than it is, according to Camilla Sutton and Sacha Tihanyi, currency strategists at Bank of Nova Scotia. The U.S. federal funds rate is 1.75 percentage points above its Taylor rule recommendation, which is below zero.
The combined difference of 2.75 percentage points indicates the two central banks will continue on opposite paths, with the Bank of Canada raising rates and the Fed providing stimulus, Toronto-based Sutton and Tihanyi wrote in a research note.
Carney said today major headwinds facing the country’s economy, and “unusual” uncertainty surrounding the economic outlook, mean the central bank needs to be cautious in raising interest rates further.
“The unusual uncertainty surrounding the outlook warrants caution,” Carney, 45, said today in the text of a speech in Windsor, Ontario. “With risks of a renewed U.S. slowdown, with constraints beginning to bind growth in emerging economies, and with domestic considerations that will slow consumption and housing activity in Canada, any further reduction in monetary stimulus would need to be carefully considered.”
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