Canadian bonds tipped to join rout

Investors in Canada’s $700 billion government debt market are bracing for additional losses, possibly outpacing U.S. declines, as Bank of Canada Governor Stephen Poloz gears up for several rate increases over the next year.

While the short-term focus is on employment and inflation data in the U.S. and Canada, the signing of a new NAFTA agreement and a $40 billion LNG project by Royal Dutch Shell Plc changed the “longer-term” sentiment, said Romas Budd, vice president and head of fixed income at 1832 Asset Management. 1832 Asset is a unit of Bank of Nova Scotia, and runs more than $100 billion of assets.

“There is a real chance for Canadian bond market under-performance in the next couple of months,” said Budd, who has shortened the duration of his Canada bond portfolio.

Canada bonds have outperformed the U.S. this year, even after yields in both countries soared this week on expectations the Federal Reserve and Bank of Canada will boost rates to tame inflation as the economies heat up. The Bloomberg Barclays Canada Aggregate bond index has declined 1 per cent this year, half the drop of the comparable U.S. index.

The yield on Canada’s benchmark debt maturing in 2028 rose to 2.55 per cent, the highest in more than four years on Wednesday, according to data. Yields on 2-year notes were unchanged, a day after reaching a decade high of 2.31 per cent.

On Friday, number showed the U.S. unemployment rate fell to 3.7 per cent in September — the lowest level since December 1969 — while hiring slowed. Employers added just 134,000 jobs, the fewest in a year, the Labor Department said Friday. But that figure was likely lowered by Hurricane Florence.

“We are tactically short at the moment and looking to cover before non-farm payrolls,” said Mark Carpani, who helps manage $1.2 billion as head of fixed income at Toronto-based Ridgewood Capital Asset Management. After “being aggressively short during this latest downdraft, it’s time to take some profits and reload.”

The Bank of Canada last tightened monetary conditions in July, increasing its overnight lending rate to 1.5 per cent. The benchmark is likely to end the year at 1.75 per cent, according to a September survey of analysts by Bloomberg News. The next announcement is scheduled for Oct. 24, with swaps trading implying a 97 per cent chance of a hike.

“For a move materially higher from here, inflation expectations will have to improve,” said Ryan Goulding, a fixed-income manager at Vancouver-based Leith Wheeler Investment Counsel Ltd., which manages $20 billion. Canadian bonds’ “near term pricing to me looks very fair when I look at what is now priced in for the BOC.”

Not all fund managers expect Canadian bonds to under-perform the U.S. “The BOC is not as aggressive in removing accommodation as the FOMC,” said Sean Simko, head of fixed-income portfolio management at SEI Investments Co, who expects Canadian and U.S. rates to move in similar fashion. “The move higher was sharp and swift. It feels a bit overextended and would not be surprised if we witnessed both markets retrace some.”

IT’S TIME TO TAKE SOME PROFITS AND RELOAD.