Swaps Show Poloz Outpacing Fed in Tightening Odds: Canada Credit

The bond market is starting to price in a greater probability the Bank of Canada will raise interest rates next year before the Federal Reserve with consumer-price increases outstripping those in the U.S.

Trading in interest-rate products shows the chances for a Canadian rate increase in the second quarter of 2015 are about 50 percent, according to calculations by Royal Bank of Canada based on banker’s acceptances contracts, the Canadian Dollar Offered Rate and overnight index swaps. The odds the Fed will raise rates at any of its four meetings in the first half of next year are below 50 percent, Bloomberg calculations based on overnight-index swaps show.

Bank of Canada Governor Stephen Poloz’s case that the risk of deflation must be countered by extending a four-year pause in rate increases is also being undermined by consumer-price gains that have topped the central bank’s forecast for three consecutive months.

“The market is now pricing in the possibility of first or second quarter of 2015,” Greg Moore, senior currency strategist at Royal Bank of Canada, said by phone from Toronto June 25. “The market has already priced out his easing bias.”

Official Guidance

Poloz, the former head of Canada’s export credit agency, has said since January that a weak dollar is needed for an export-led recovery, and that he can’t rule out a rate cut. Poloz surprised investors by abandoning language in October that higher rates would become appropriate, a warning repeated by predecessor Mark Carney for a year.

“You’ve had a central bank talking about two-sided risk, and you have economic data that tells the market there’s only one side,” Steven Englander, the global head of G-10 foreign-exchange strategy at Citigroup Inc., said in a telephone interview June 23. “It’s basically a mixture of stalling and praying for rain.”

The latest forecasts by economists show the Bank of Canada and the Fed increasing rates in the third quarter of 2015. The Fed has maintained its target for overnight loans between banks at a range of zero to 0.25 percent since 2008. The Bank of Canada has kept its key rate at 1 percent since 2010.

Swap Spread

Overnight index swaps, or OIS, which give traders predictions on what rates will average for the term of the swap, indicate a faster timetable for Canada. The London interbank offered rate-OIS spread, the measure of bank lending, was 27.3 basis points, compared with 12.47 basis points for the U.S. rate at 8:30 a.m. in Toronto.

Poloz will deliver the central bank’s next rate decision and its quarterly forecasts, known as the monetary policy report, on July 16.

Inflation exceeded the Bank of Canada’s 2 percent target last month for the first time in more than two years, an unexpected acceleration led by energy costs, Statistics Canada said June 20 from Ottawa. The consumer price index rose 2.3 percent from a year earlier following April’s 2 percent gain, belying the Bank of Canada’s April 16 prediction that inflation will return to its target in the first quarter of 2015.

“Inflation is increasing, which suggests that the BoC governor should eventually need to adjust his speech accordingly,” said Hendrix Vachon, senior economist at Desjardins Securities Inc. in Montreal.

Vachon, the most accurate forecaster of major currencies for the four quarters ended March 31, projects the Canadian dollar will appreciate to C$1.075 per U.S. dollar by the end of the year. The Canadian currency climbed to C$1.0678 today, the strongest since Jan. 6.

“We expect a less dovish tone by the end of the year” from the Bank of Canada, Vachon said.

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