RBC Plots Parallel Universe as Economists Hold On: Canada Credit

Royal Bank of Canada credit analysts are contemplating an alternative reality to the interest-rate estimates of the nation’s biggest bond underwriter with yields lingering below official forecasts.

The lower-for-longer scenario was presented in a May 23 note to clients side by side with the bank’s higher-rate view, detailing how lower yields would help pipeline developers and hurt bonds of banks, life insurers and phone companies with large pension plans. Ten-year bond yields would end the year at 2.5 percent, closer to where they are now, rather than the 3.05 percent sanctioned projection.

“This is an alternative scenario,” Altaf Nanji, head of credit research at RBC Capital Markets, said by phone yesterday from Toronto. “Some feel we could be stuck at these low levels for much longer. If you buy into that notion, then your sector preferences would probably change.”

Concern that anemic growth will discourage central bankers around the world from lifting borrowing costs is prompting Canada’s second-largest lender by assets to revisit its forecasts. On average since 2012, the firm has called for the first rate increase since the financial crisis at least one quarter before the median forecast by peers, according to data compiled by Bloomberg.

RBC’s “base-case’” continues to be for higher underlying borrowing rates. The Toronto-based bank hasn’t changed its official sector calls, which favor bank bonds and underweight pipeline developers including Enbridge Inc. and TransCanada Corp., borrowing to create links out of Canada’s landlocked oil sands and the nation’s biggest non-financial corporate issuers.

Stagnation Story

Exports are failing to jolt a halting recovery in an economy too dependent on debt-fueled consumer growth, Bank of Canada Governor Stephen Poloz said April 16. Poloz has moved from talking about raising the policy interest rate to contemplating an interest-rate cut, and has revised the central bank’s forecast for 2014 growth to 2.3 percent from 2.5 percent.

“A lot of folks have talked about this global stagnation story and how the developed world has been growing more slowly,” David Madani, an economist at Capital Economics, said by phone yesterday from Toronto. “There’s a creeping sense now the new normal is much lower and there’s potentially portfolio reshuffling going on at institutions. Markets are trying to figure out what is the new normal, and what does it mean.”

Madani’s forecast is for 10-year bond yields to reach 3 percent by the second quarter of 2015, six months later than the weighted average of 20 economists surveyed by Bloomberg.

Market Pressure

Yields on the 10-year bonds, which last touched 3 percent almost three years ago, were at 2.22 percent as of 2:25 p.m. in Toronto, a decline of 54 basis points, or 0.54 percentage point, since Jan. 1.

Even as the Federal Reserve starts slowing its monthly purchases of Treasuries and mortgage-backed securities known as quantitative easing, other buyers have emerged, surprising traders expecting a surge in yields.

Mark Chandler, head of fixed-income research at RBC, said a U.S. recovery will push Treasury yields higher in the second half of the year and take Canadian yields along.

“A lot of the pressure comes from rising yields in the U.S. as the U.S. economy recovers,” Chandler said by phone yesterday. “There are going to be some inflation pressures and that part of it is common to both Canada and the U.S.”

Economists surveyed by Bloomberg News from May 2 to May 8 cut forecasts for the next eight quarters versus projections last month, putting the 10-year yield at a weighted average of 3 percent by the end of this year. That’s the lowest level in surveys dating back to July, and down from 3.14 percent in an April survey.

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