Bond bears seen losing bravado with yields touching 7-year high

Bears feasting in Canada’s government bond market may be getting a little too greedy.

Yields on two-year and five-year government debt have reached the highest since 2011, surging 120 basis points since June. That mirrors a rise in 10-year U.S. Treasury yields which pushed past the three-per-cent barrier for the first time since 2014 this week.

But Canada is no U.S., where economic growth is forecast to be stronger this year amid corporate tax cuts and increased fiscal spending. Growth in Canada is poised to slow markedly from 2017 and that may push investors to reassess their views for interest-rate increases in the world’s 10th biggest economy, according to Sun Life Investment Management and Toronto-Dominion Bank.

“As expectations for growth set around two per cent, you could certainly have scope for yields to move lower” later this year, said Randall Malcolm, head of fixed income at Sun Life Investment Management in Toronto, which has $37 billion (US$29 billion) in money market and fixed income assets.

Bank of Canada governor Stephen Poloz held the central bank’s benchmark interest rate steady at 1.25 per cent last week after three previous hikes and gave few signs he’s in a hurry to raise them further. Inflation may have risen above the middle of the central bank’s target but he sees that as temporary and made clear the target is a range.

“What I don’t want is for people to be spending this entire year asking me what I’m up to because inflation is above target,” Poloz told reporters in Washington Saturday. “You need once in a while to remind people that there’s a range and that’s okay ...”

The latest inflation reading came in at 2.3 per cent, above the two-per-cent midpoint, yet still well below the top of the target at three per cent. The economy is seen slowing to 2.1 per cent this year, from three per cent, according to forecasts compiled by Bloomberg, as both housing and industrial output are expected to take a breather.

The bond market doesn’t seem convinced. Canadian federal government debt lost 2.3 per cent in the past year and is down 0.8 per cent year-to-date, on track for its worst year since 2013, according to a Bloomberg Barclays index.

Both two-and five-year yields have gone too high with the market expecting the Bank of Canada to move too swiftly with hikes, according to Toronto-Dominion Bank’s senior rate strategist Andrew Kelvin. The market consensus is for two more rates increases, most likely in July and either in October or December, according to data compiled by Bloomberg. TD expects one hike this year, in July at the soonest.

“Insofar as the Bank of Canada can tighten much more slowly than the Fed can, there is scope for frontend rates in Canada to diverge from U.S. Treasuries,” Kelvin said. He sees the spread between U.S. and Canadian two-year yields widening further to 65 basis points from 57 basis points, the highest since June, as yields north of the border retreat and U.S. yields reach a ceiling.

Candice Bangsund, a portfolio manager at Fiera Capital, is wary about jumping into Canadian government debt yet. The Montrealbased fund manager recommends staying underweight fixed income but would look for opportunities in the corporate sector. “Rates are going higher across the entire curve, more so at the long end,” Bangsund said in an interview on BNN TV on Wednesday. A “stronger global economy and higher crude prices should lend support to the riskier sectors of the market versus the government bonds.”