Bonds tell tale of sound recovery

Paul Vieira, Financial Post · OTTAWA — The fixed-income market, considered among the best of forward-looking indicators, suggests the economic recovery is picking up steam in Canada and the central bank may deliver another rate hike as early as March of next year.

Yields across the curve have reached levels last seen in June and July when the Bank of Canada commenced a short-lived rate-hike campaign. And at that time, there was no talk of the U.S. Federal Reserve needing to inject hundreds of billions of dollars of additional liquidity into the U.S. economy to jump-start the recovery.

Two-year bond yields, a great indicator of where the Bank of Canada’s benchmark rate might be headed, have jumped nearly 40 basis points in barely a month since the last central bank decisions.

Meanwhile, yields on five- and 10-year government of Canada notes have moved upward 46 and 33 basis points, respectively, since the beginning of November, which mirrors activity in the U.S. Treasuries market.

“We have seen a heavy-duty selloff in recent weeks, right up and down the yield curve in Canada,” said Douglas Porter, deputy chief economist at BMO Capital Markets.

Experts say this is a combination of heightened inflation expectations and this week’s stronger-than-expected consumer price data in Canada, signs of an improving U.S. labour markets, and a realization among investors that yields are just too low.

And whereas most Bay Street economists had forecast that the Bank of Canada rate wouldn’t resume movement until July, the fixed-income market has now priced in 50-50 odds of a rate increase of 25 basis points, to 1.25%, in March.

The rise in yields also emerges as the Fed kicks off its US$600-billion asset purchase plan — designed to pull down borrowing costs — and Europe’s debt woes re-emerge, perhaps prompting investors to park cash in safer government debt, such as Canada’s.

“Clearly, the bigger issue of where the market believes the U.S. economy is going and, ultimately, Fed rate policy is going seems to have had much greater pull on bond yields — and it is higher,” Mr. Porter said.

Eric Lascelles, chief Canadian strategist at TD Securities, said Canadian bonds have, like their U.S. counterparts, sold off in recent weeks after investors bought debt in the preceding weeks leading up to Fed’s decision to pursue further easing.

“But in fairness, that sell-off in the United States has not been as large, so there certainly is a made-in-Canada phenomenon at play as well.”

In its last rate statement, in which the benchmark rate was left unchanged, the Bank of Canada made significant downward revisions to its growth outlook, and pushed back the date, by a year, as to when economic slack is absorbed and inflation is set to hit the preferred 2% target.

But October inflation data indicated consumer prices rose on 2.4% on a year-over-year basis, much stronger than expectations, while core inflation — which strips out volatile-priced items — rose 0.3% month over month, the biggest such increase since February. Core inflation now stands at an annual rate of 1.8%, which is just below the Bank of Canada 2% target and above the central bank’s forecast.

Other fixed-income watchers, meanwhile, indicate traders are growing more confident about the global recovery based on better U.S. data. There have been five straight months of private-sector job creation above the 100,000 level — with November expected to continue the trend — and U.S. initial jobless claims dropped this week to their lowest level in two years.

On top of that, annual growth in corporate profits is set to hit 30% this year, and third-quarter GDP growth, at 2.5% annualized, was above expectations.

“Housing remains a serious Achilles heel, but the U.S. consumer is in increasingly better shape in terms of wage growth and confidence, and corporations are starting to use the trillions they had set aside for the double-dip recession that never came,” said Hank Cunningham, fixed-income strategist at Odlum Brown. “So the bond market decided yields were too low.”
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