Pimco finds silver lining to Canadian gloom in bond-market gains

Canada’s souring economy is giving the country an edge in the fixed-income market, where it’s beating Group of Seven peers and drawing buyers including Pacific Investment Management Co.

Pimco, which manages about US$1.52 trillion, is among investors betting Canadian debt will keep outpacing Treasuries after the Bank of Canada lowered its benchmark rate for the second time this year and ratcheted back growth forecasts.

“We have and will continue to position our portfolios to take advantage of that,” said Pimco’s Ed Devlin, who oversees about US$17 billion in New York, including the Canadian Total Return Bond Fund. “We would think the U.S. con- tinues to underperform Canada.”

At about 1.5 per cent, Canada’s 10-year yields are about 0.8 of a percentage point below those on similar-maturity Treasuries, the biggest gap in Bloomberg data going back to 1989. Pimco’s Devlin said the spread may keep widening.

The Bank of Canada reduced its benchmark interest rate to 0.5 per cent Wednesday.

Canada’s economy is feeling the pain from its dependence on commodities. Crude oil, Canada’s biggest export, has dropped about 50 per cent from a year ago, fuelling speculation the Bank of Canada isn’t done trimming borrowing costs.

“With oil hovering at a price well below that which would get Canada out of the doldrums, this may not be the last cut,” Luke Bartholomew at Aberdeen Asset Management in London wrote in a note Wednesday.

The firm manages US$491

The trigger would be the U.S. markets selling off

billion. “It highlights the gulf between the U.S. and Canada as the Fed looks to raise rates this year.”

The prospect of the Fed’s first rate increase since 2006 may bolster demand for Canadian bonds, said Pimco’s Devlin.

“The gap could still go wider,” he said. “The trigger would be the U.S. markets selling off in anticipation either of a September or December rate hike.”

Investors have earned 2.7 per cent in Canadian bonds this year through July , more than every other G-7 peer, according to a Bank of America Merrill Lynch index. Last year, Canada’s debt trailed every G7 nation except the U.S. and Japan. The group’s other members are France, Germany, Italy and the U.K.

The rate divergence between Canada and the U.S. is rare. The nations are the world’s largest two-way trading partners, with the U.S. accounting for 75 per cent of Canada’s exports.

“I wouldn’t be surprised if the Canadian economy turned out to be a little more weak than this forecast,” Alessio de Longis, a money manager at OppenheimerFunds Inc., said from New York. De Longis, whose firm oversees about US$235 billion, sees the Canadian economy expanding by less than one per cent this year and is betting its currency will decline.

“When your exports are not competitive, even a rebound in the U.S. no longer helps,” he said.