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Canadian bond yields reach new low amid speculation of rate cut

Looking up at four of Canada's major banks from the south west corner of Front King. West and Bay St. on March 30.

Fred Lum/The Globe and Mail

Canadian benchmark bond yields fell to a new record low on Thursday, as the market increasingly bets on a rate cut to insulate the domestic economy from the oil crash.

With yields around the world declining this year as investors forsake riskier assets in favour of safe havens such as government bonds, Canadian 10-year government yields touched a record low of 1.192 per cent on Thursday.

The Canadian five-year benchmark yield marked its own new low point a day earlier, opening up a spread against its U.S. equivalent reminiscent of some dire economic episodes in Canada's past, said Mark Chandler, head of fixed income research at Royal Bank of Canada.

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"We're at a point where it's almost unprecedented," he said. "If you think about market sentiment right now, it's almost like Canada's not going to live through this."

The short year so far has seen market losses pile up in Canada at an alarming pace.

The Canadian dollar dipped to a new 13-year low of $0.6946 against the U.S. dollar on Thursday.

Oil sank below $30 (U.S.) a barrel on Tuesday for the first time since 2003, before rebounding modestly.

Meanwhile, the S&P/TSX composite index dipped to its lowest intraday level since July, 2013, in morning trading on Thursday before rebounding, as longer-term bond yields fell.

A thin majority of economists now expect the deteriorating conditions will compel Bank of Canada Governor Stephen Poloz to cut the overnight lending rate by 25 basis points to 0.25 per cent next week. The key policy rate has not been set that low since the depths of the financial crisis in late 2009 and early 2010.

"It was more just the persistent relentless downward dive in oil and other commodity prices that was reason number one," Doug Porter, chief economist at BMO Capital Markets, said in explaining his forecast change to expect a cut.

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On Wednesday, the Canadian benchmark five-year yield fell to as low as 0.511 per cent, which is the lowest level on record, according to Bloomberg data going back to 1989. That rate is also barely above the current overnight lending rate at 0.50 per cent.

Normally, the longer the term of a bond – the further along on an upwardly sloping yield curve – the greater the return demanded by investors as compensation for additional risk.

"When the curve flattens like that, it's usually interpreted as a sign of increasing pessimism about the state of the economy," said Avery Shenfeld, chief economist at CIBC.

The spread between Canadian and U.S. five-year yields currently sits at about 90 basis points after having peaked at 105 basis points at the end of December, which are levels typically reserved for times when the Canadian economy is in much worse shape than that of the United States, Mr. Chandler said.

He cited the recession of the early 1980s, as well as the years of Canadian fiscal tightening to cut national debt in the 1990s as examples.

"We lived through that," Mr. Chandler said.

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The current oil-induced domestic trepidation accelerated this week with oil slipping below the $30-a-barrel mark. That current price is approaching levels where "existing production becomes uneconomic," and increases risks that production shutdowns will exacerbate the impact, David Tulk, Toronto-Dominion's head of global macro strategy, said in a note Wednesday.

Trading in overnight index swaps shows investors are putting the odds of a rate cut at about 50 per cent, compared with 16 per cent a month ago.

Mr. Poloz cut his overnight rate twice last year – in January and July – to guard against the damage of crude oil prices that slumped to less than $50 a barrel from more than $100.

"We see the odds having tilted in recent days, and are now ever so slightly on the side of seeing a rate cut in January, or April at the latest," Mr. Shenfeld wrote in a research note Thursday. "The Bank may feel that a cut now would not be a shocking surprise to the Canadian dollar or other markets."

Mr. Shenfeld says he's not so sure about that.

"At this point, you're playing with fire, because the currency has weakened pretty sharply, and you don't want to set off a runaway exchange rate," he said. "I think the currency is weakening enough on its own, and the real weapon that's still available is fiscal policy."

With a report from Bloomberg News



A growing number of observers now believe the Bank of Canada could cut interest rates again next week. Economists have been marking down their prospects for economic growth this year along with their projections for oil prices. Here's the latest:

Douglas Porter and Benjamin Reitzes, BMO Nesbitt Burns

"Next week marks the one-year anniversary of the Bank of Canada's shock decision to cut interest rates - i.e., a day of infamy for Canadian financial market forecasters. We now suspect that the balance of factors leans towards a third 25-basis-point rate trim at Wednesday's decision, bringing the overnight rate full circle to the lows reached in 2009-10 at 0.25 per cent. Such a move would be much less of a shock than a year ago."

Charles St-Arnaud, Nomura

"With oil prices having declined significantly in recent months, reaching their lowest levels since 2003, and indications that growth stalled in Q4, we believe there will be further drag to growth in 2016 coming from capex and commodity-related sector. As a result, we believe that the Bank of Canada will cut its policy rate by 25 basis points to 0.25 per cent at next week's meeting, to buy some protection against a worsening of the economic situation."

Avery Shenfeld, CIBC World Markets

"We see the odds having tilted in recent days, and are now ever so slightly on the side of seeing a rate cut in January, or April at the latest. That's not based on a recommendation to do so, as at this point, we're concerned about risks of a runaway [Canadian dollar], believe the currency to be weak enough to do the job on the trade side, see little if any benefit in terms of generating more debt financed private sector activity, and would argue that a larger fiscal stimulus package that has the federal government do the additional borrowing/spending would be preferable for longer term financial stability."

Emanuella Enenajor, Bank of America Merrill Lynch

"If energy prices remain persistently low, one rate cut will not likely be enough to stimulate the economy back to a reasonable growth path. In that case, the BoC may adopt forward guidance later in 2016. Another possible scenario is that the federal government ramps up its infrastructure stimulus spending to provide a greater boost to the economy than initially planned."

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