Investors Aren’t Buying Bank of Canada Gloom as Hike Bets Mount

  • Rate on two-year debt rose to highest since 2015 this week
  • Bonds follow U.S. Treasuries as markets prepare for Fed hike

What the Fed's Rate Hike Means for Canada

Economists may be saying the Bank of Canada is on hold but the bond market is already starting to price in the chance the central bank will follow the Federal Reserve with higher rates this year.

The yield on Canada’s two-year bonds rose to a two-year high this week and overnight index swaps traders have pushed the probability of a rate increase to 51 percent by December, according to data compiled by Bloomberg News. By contrast, just two of 18 economists surveyed by Bloomberg see an increase this year.

“I’m a little bit surprised by the extent to which the front end of the curve has been willing to price in tightening from the Bank of Canada,” Andrew Kelvin, senior fixed-income strategist at TD Securities, said by phone. “I understand where the markets are coming from because historically the Bank of Canada had had to follow suit, but if you look at the cycle, we’re not seeing the same degree of synchronization of the Canadian and U.S. economies.”

Federal Reserve officials are expected to announce an interest-rate increase Wednesday after solid U.S. jobs data and comments from Chair Janet Yellen earlier this month that a hike in March “would likely be appropriate” if the economy stays on track. That would be the first of three hikes the market is expecting for the U.S. this year, according to fed funds futures data compiled by Bloomberg.

Canada’s central bank, meanwhile, has looked past recent signs of improvement in the country’s economy, highlighting labor market weakness and global uncertainties as it kept its benchmark interest rate unchanged at 0.5 percent at its March 1 announcement.

The bond market is taking a different view. The yield on Canada’s federal government bond due February 2019 rose to 0.87 percent on Monday, climbing for five straight days, before dropping two basis points on Tuesday.

“That’s a bit aggressive as just two weeks ago the Bank of Canada came out continuing to highlight all the excess capacity in the Canadian economy,” said Joey Mack, director of fixed income at GMP Securities LP in Toronto. “The short end has got a bit ahead of itself.”