A BOND FOR EVERY SEASON
RSP Season: January to March Banks, investment dealers and mutual funds get huge inflows of cash in the run-up to the annual March 1 tax deadline for RSP contributions. They usually park that money in Treasury bills (30, 90, 180 or 360 days) and bonds with relatively short durations (one, two or five years). Those issues offer safety and a small return while money managers decide where to invest more permanently.
Mortgage Season: late March to early July Home sales tend to peak near the end of the school year. Banks typically give prospective homebuyers a 120-day commitment for a maximum mortgage size and an interest rate. To cover part of those commitments, banks will often sell five-year GofC bonds. This generates cash that they can lend. The bulk of mortgage loans have five-year terms. When the actual loans come on the banks' balance sheets (remembering that loans are assets for a bank), they have essentially traded one asset with a five-year term for another that they expect will earn a higher return.
Rollover Days: June 1 and Dec. 1 About 80% of GofC bond issues currently outstanding pay interest on June 1 or Dec. 1 each year, and they will mature on one of these dates. Investors typically use the cash they receive to buy more bonds. About $6.5 billion worth of coupons will come due this Dec. 1 and next June 1, and the value of bonds maturing will be $7.3 billion on Dec. 1 and $15.8 billion on June 1. But it's hard for traders to predict where the rollover money will go-investors don't necessarily buy bonds of the same duration as the ones they had.
BUT WHAT ABOUT THE DOLLAR? If foreigners buy Government of Canada bonds denominated in Canadian dollars, any swings in the value of the dollar will directly affect their returns. This is one of many reasons why the Bank of Canada is concerned about the dollar when it makes interest rate decisions. But currency markets are huge and trade electronically 24 hours a day around the globe, so the dollar can get knocked around by a lot of other influences besides the Bank's decisions.
Oct. 19 provides a good example: The Bank of China's surprise decision to raise its rates by a quarter-point comes at 7 a.m. Eastern time; the euro and the U.S. dollar jump immediately. Analysts and traders take the hike as a sign that China might relent in its strategy of keeping the value of the yuan low, which has helped it rack up huge trade surpluses with the United States and the European Union.
The Canadian dollar is hammered quickly, too. By 9 a.m., when the Bank of Canada announces its decision to stand pat on interest rates, the dollar is down more than a cent and a half relative to the greenback. But only about a third of that decline comes immediately after the Bank of Canada news; the rest is China's work. Wayne Baker, RBC's global head of trading the Canadian dollar, figures the market absorbed that decision in about two minutes. "Not even that," he says with a grin. "Probably two seconds."
HOW LONG CAN THE BOND BUBBLE LAST? The short answer is: as long as the U.S. Federal Reserve can keep printing money. On Nov. 3, the Fed announced that it will spend $600 billion (about $75 million a month) over the next eight months to buy long-term U.S. Treasury bonds. It's called "quantitative easing," a practice central banks occasionally use to pump-prime a stalled economy. The Fed buys the bonds from commercial banks, thereby filling the banks' coffers with cash. The idea is that they'll lend out that money at low interest rates, and that will give the U.S. economy a lift. The Fed has already spent $1.75 trillion buying Treasuries and government-backed mortgage bonds since early 2009, a tsunami of cash that's helped to push down bond yields worldwide.
Do bond traders worry that the bubble will burst? Stealing a bon mot from Alan Greenspan: yes and no. "Too much cash in the system before 2000 contributed to the run-up and crash of the tech market in 2000, and interest rates held too low for too long were a factor in the credit crisis [of 2007-'08]" says RBC's Byrd. But Fed chairman Ben Bernanke is worried about a double-dip recession. "It's a bubble that's here to stay in the short-to-medium term," says Byrd. "Does it change our day-to-day activities? No, but it's something to be cognizant of at all times." U.S. Treasury yields remain near historic lows. When the Fed does start to pull back, that will be a dramatic day on world bond markets indeed.