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The Bank of Canada is buying billions of dollars worth of bonds each week to try to keep long-term borrowing costs down, and now has to contend with a U.S.-driven surge in yields.Chris Wattie/Reuters

The steady rise in bond yields since the beginning of the year went into overdrive this week, roiling markets and raising questions about whether central bankers are losing control of the narrative around the timeline for a postpandemic economic recovery.

Government bonds around the world sold off sharply, causing yields to jump to levels last seen in February, 2020. Bond prices and yields move in opposite directions, and investors tend to sell longer-dated bonds when they expect inflation to increase and interest rates to rise.

While central bankers continue to warn that an economic recovery remains a long way off, markets have begun to price in much faster growth, leading to higher real (inflation-adjusted) yields. This divergence is causing a kind of feedback loop, in which dovish comments from central bankers – painting a cautious picture of the economy and promising to maintain high levels of stimulus – may be fuelling growth and inflation expectations in the market.

“The markets listened to [the central banks] for so long and believed the narrative, that now as we get new pieces of information, they’re starting to question the persistence of the narrative they’re providing,” Ian Pollick, head of fixed income strategy at CIBC World Markets, said in an interview.

“You’re now stuck in this vicious cycle, where the longer central bankers are suggesting rates will stay low, it’s actually underwriting the move higher in bond yields,” he said.

Yields on government bonds around the world have been moving consistently higher since the beginning of the year. Much of the momentum is owing to better-than-expected economic data from the United States, where massive fiscal stimulus and a robust COVID-19 vaccination campaign has improved the economic growth outlook for 2021 and 2022. Most developed-economy bond markets, including Canada’s, are closely tied to the U.S. bond market.

The sell-off picked up pace this week, with a particularly sharp jolt on Thursday. The yield on 10-year U.S. treasuries rose 16 basis points (each one-hundredth of a per cent) to more than 1.6 per cent, before settling down to around 1.4 per cent by the end of day Friday. Prior to this week, many analysts had not expected rates to climb that high before 2022.

“We’ve gone from a steady move higher in rates to a rather violent one. And on top of that you have federal reserve officials who have been very blasé about it, which only serves to encourage the sell-off,” said Andrew Kelvin, chief Canada strategist at TD Securities.

“Yesterday you had a U.S. bond auction that went rather poorly, which added fuel to the fire,” he said in an interview.

The repricing this week puts the Bank of Canada, like other central banks, in an awkward position. It is buying billions of dollars worth of bonds each week to try to keep long-term borrowing costs down, and now has to contend with a U.S.-driven surge in yields.

Canadian rates typically move less dramatically than U.S. rates. However, Canadian bond yields have risen even faster than U.S. yields since the beginning of the year. That’s largely because of expectations the Bank of Canada will begin “tapering” its pace of government bond buying (quantitative easing) and raise rates sooner than the U.S. Fed.

“For now they’re saying these are reflecting more optimistic economic conditions, more optimistic growth conditions, so that’s fine, we’ll allow it to happen,” Taylor Schleich, rates strategist with National Bank of Canada Financial Markets, said in an interview.

“But I do think there’s some point ... that they’re going to become uncomfortable with how high rates have gotten. We might not be there yet. But you can’t continually rise like 10 basis points, or 20 basis points a day, and the central bank is not going to do anything about that,” he said.

While the speed of the sell-off this week rocked markets and caused a headache for central bankers, Mr. Schleich doesn’t expect it to continue at the same pace. Rates have risen by more than 50 basis points over a two-month period 15 times in the past 20 years, he wrote in a note to clients. On average, they declined five basis points in the subsequent two months.

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