Canadian Bonds Lose Most in One Year as Traders Switch Rate Bets

Updated on
  • Swaps show better chances for BOC increases than cuts in 2016
  • Stronger-than-projected data from economy boost confidence

Canadian government bonds ended their worst month in a year as investors switched bets to central bank interest-rate increases from cuts on signs of economic strength and a crude-oil rally.

The country’s sovereign debt lost 0.8 percent in April as the yield on its 10-year note surged 29 basis points, or 0.29 percentage point, the steepest monthly increase since June 2013, according to data compiled by Bloomberg. The benchmark Standard & Poor’s/TSX Composite Index rose 3.4 percent in April, while crude oil gained almost 20 percent.

Canadian debt suffered as investors favored riskier assets on growing confidence the world economy will avoid a downturn. Even as crude oil’s biggest monthly advance in a year isn’t enough to generate added investment in the industry, Canada’s economy may get up to “full speed” this year as non-energy exports pick up, Bank of Canada Governor Stephen Poloz said last week.

“Poloz’s speech maybe wasn’t bullish, but it was very undovish,” said Andrew Kelvin, a senior fixed-income strategist at Toronto-Dominion Bank. “He came across very confidently that it would take a significant slowdown for them to cut rates.”

Stayed Put

Overnight index swaps show the probability of an interest-rate increase this year reached 18 percent, while the likelihood of a cut fell to 5 percent, down from 81 percent on Jan. 14. That was a week before a central bank meeting that analysts including Toronto-Dominion’s Kelvin had thought would conclude with a quarter-point cut in interest rates to 0.25 percent, a record low only ever seen in the wake of the global financial crisis.

The central bank stayed put and most macroeconomic data released since showed faster-than-estimated improvement in Canada’s economy. 

HSBC Holdings Plc, one of four banks still expecting a rate cut this year, holds the most bullish view on Canadian bonds, seeing the yield on the country’s 10-year note falling to 1.1 percent by the end of the year from 1.52 percent at 12:08 p.m. in Toronto, driven down mainly by risks to global growth.

Continued Headwinds

“We’ve had a tendency to be very below-consensus just because we’re focused on what could possibly go wrong and we keep getting a long list,” said Lawrence Dyer, a New York-based interest-rate strategist at HSBC. “The risk that investors should be focusing on is continued headwinds from the global economy.”

There are also questions about the stability of the capital flows out of bonds to riskier assets, which may be “more about an unwinding of positions rather than real investment flows,” Aubrey Basdeo, head of Canadian fixed income at BlackRock Inc., said in an interview in Toronto on April 27.

“These have to be supported by demand in the economy and I haven’t seen many stories about demand picking up,” Basdeo said, adding he sees the Bank of Canada staying “firmly on hold” this year.

Even as Canadian bonds lost money last month, they outperformed all 26 developed-market peers except for Japan in Canadian dollar terms, Bloomberg indexes show, largely because of the currency strengthening. Canada’s dollar has gained 10.3 percent versus its U.S. counterpart this year.

Economic Results

While gross domestic product shrank by 0.1 percent in February, the contraction was smaller than anticipated and first-quarter growth is on track to come in at a 2.9 percent annual pace, which would be the fastest since 2014, according a median of forecasts compiled by Bloomberg. Businesses added 40,600 jobs in March, beating all forecasts in a Bloomberg News survey, while inflation and core inflation both exceeded analysts’ expectations.

The recent recovery in Canada’s economy will likely fade, according to the MLI Leading Indicator. The index was unchanged in March, the fifth-straight month the measure failed to increase. Canadian bonds fell on April 26, pushing the yield on the 10-year bond to a four-month high 1.58 percent.

The rate will go up to 2.51 percent by the end of the year as the central bank moves closer to an interest-rate increase that could take place already in the first or second quarter of 2017, according to Moody’s Analytics Inc., the most bearish forecaster of Canadian bonds among those surveyed by Bloomberg. Canada’s economy will accelerate to 2.4 percent in 2016 and further to 2.9 percent in 2017, getting support from the federal government’s expansive fiscal policy, it says.

Prime Minister Justin Trudeau is ramping up benefits, allocating billions more in infrastructure, topping up funding for climate change initiatives, raising taxes on the rich, and cutting taxes for everyone else. The budget will run deficits of C$29 billion ($23 billion) during the next two years, with spending at levels not seen in decades outside of the 2009 recession.

“With the new government budget much more focused on deficit spending rather than austerity, that will boost the economy even more,” said Adam Goldin, an economist at Moody’s Analytics. “There is actually an upside potential, not a big one, that rates could go higher a little bit faster because of the budget deficits.”