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GLOBAL INVESTORS ARE AGGRESSIVELY ADJUSTING THEIR CANADIAN PORTFOLIOS, SHEDDING GOVERNMENT BONDS IN FAVOUR OF CORPORATE NOTES. STATISTICS CANADA REPORTS THAT BOND HOLDINGS BY FOREIGN INVESTORS FELL $3.9 BILLION IN JUNE, THE FIRST SUCH DIVESTMENT SINCE JAN

Some hard truths about the easy money floating around capital markets.

As New York portfolio manager Michael Gayed recently pointed out in MarketWatch, the U.S. Federal Reserve is desperate to raise interest rates to more equilibrium levels so it can eventually lower them again “to fight the next recession, which for all we know, may be coming much sooner than we think.”

In Canada, the benchmark interest rate sits at a relatively high 1%, which is why Bank of Canada Governor Stephen Poloz insists he can wait things out. But the neutral rate in this country was about 4% prior to the financial crisis. And, as freely admitted by Poloz’s predecessor Mark Carney, there are limits to the central bank’s independence because of the intertwined nature of the North American economy. If U.S. rates head for neutral territory, it is a good bet that Canadian rates will follow suit. If that happens, nobody will want to be holding government bonds issued at current rates.

That said, with inflation in many other countries below 1%, the global economy isn’t ready for rates to rise. Calls for more quan- titative-easing ( QE) programs are increasing outside the U.S., which started tapering emergency purchases of Treasury bonds and mortgage-backed securities this year. Keep in mind that QE has also been the primary driver of economic recovery in Japan, where it now appears the Bank of Japan will have to increase its stimulus efforts to fight unexpected headwinds that appeared in the second quarter. Meanwhile, the European Central Bank is desperately trying to fend off deflation and traditional monetary policy isn’t doing the trick. In early September, ECB President Mario Draghi dropped interest rates to as low as technically possible and launched a QEprogram despite significant German resistance to the idea.

Simply put, as U.S. fund manager David Kotok points out, worldwide deflation fear is expanding, not contracting. And with politicians still relying on central bankers to do the heavy lifting on the economic recovery front, short-term interest rates will probably remain near zero for a long time, even south of the border.