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Inside the Market Bond market sends scary signal about where Canada’s economy is heading vs. the U.S.

The bond market is telling an ugly story about how Canada’s economic outlook compares with that of the United States – one of the ugliest stories in three decades, in fact.

The difference between the yields on 10-year government bonds in the two countries has recently swelled close to its largest level since 1989. There are various ways to interpret this growing gap, but one reasonable explanation is that investors see considerably stronger prospects for growth in the United States than in Canada.

The increasing spread reflects the precipitous decline in Canadian bond yields. In early October, a 10-year Government of Canada bond was yielding a hair under 2.6 per cent. Today, it is paying just more than 1.7 per cent.

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Falling Canadian bond yields are part of a larger story about how central banks around the world attempted to raise rates in 2018 but met surprising resistance. In the United States, Europe and Canada, shaky stock markets and slowing growth have prompted policy-makers to back off plans for higher rates and tighter monetary policies.

Canadian savers have already felt the impact of this retreat. GIC rates spiked higher in the latter half of 2018, in anticipation of higher rates ahead, but have slid in recent weeks. Oaken Financial, for example, was paying 3.1 per cent on a one-year GIC late last year. It lowered the one-year rate to 3.0 per cent earlier this month, then on Tuesday announced plans to cut it further to 2.75 per cent.

On a brighter note, falling bond yields should eventually be reflected in lower mortgage rates. That may provide support for Canada’s wobbly real estate market. In February, the Teranet-National Bank National Composite House Price Index declined 0.4 per cent from the preceding month, the largest February decline in the 19-year history of the index outside of the recession year of 2009.

However, declining rates aren’t great news for anyone if they simply reflect a slowing economy. That is why the divergence between Canadian and U.S. bond yields are of concern.

A government bond yield incorporates many factors, but the two most notable are compensation for the real economic growth that investors expect and an offset for expected inflation.

Inflation expectations have fallen in both Canada and the United States in recent months, but the implied outlooks for growth have fallen even more. The decline has been particularly notable in the case of Canada and that has opened up the sizable gap between U.S. and Canadian government bond yields.

U.s.-canada 10-year treasury spread

Quarterly

0.8788%

1.0%

0.5

0.0

-0.5

-1.0

-1.5

-2.0

-2.5

‘90

‘95

‘00

‘05

‘10

‘15

‘19

JOHN SOPINSKI/THE GLOBE AND MAIL

SOURCE: bloomberg

U.s.-canada 10-year treasury spread

Quarterly

0.8788%

1.0%

0.5

0.0

-0.5

-1.0

-1.5

-2.0

-2.5

‘90

‘95

‘00

‘05

‘10

‘15

‘19

JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: bloomberg

U.s.-canada 10-year treasury spread

Quarterly

0.8788%

1.0%

0.5

0.0

-0.5

-1.0

-1.5

-2.0

-2.5

‘90

‘95

‘00

‘05

‘10

‘15

‘19

JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: bloomberg

Despite suffering its own decline in yield, the 10-year U.S. government bond still pays just more than 2.6 per cent, about 88 basis points more than its Canadian counterpart. (A basis point is one-100th of a percentage point.)

A gap of this size is rare. The largest spread in the past 30 years occurred in late 2015, when the gap briefly topped 89 basis points, according to Bloomberg data. Today’s divergence is less than two basis points off the record.

The spread underlines concerns around the Canadian economy. While unemployment remains low, a cooling housing market, lacklustre oil prices, global trade tensions and high levels of consumer debt all offer reasons for worry.

Earlier this month, the Bank of Canada acknowledged that “the slowdown in the global economy has been more pronounced and widespread” than the central bank had expected. It hopes that growing exports and a happy conclusion to the U.S.-China trade talks will help boost Canadian growth in 2020.

Perhaps so, but Canadian shoppers will have to contribute to any rebound in growth, and that is far from certain. “Consumers’ housing wealth declined last year for the first time in three decades,” Stephen Brown of Capital Economics wrote in a note this week. “The modest fall is unlikely to cause a drop in consumption, but it does suggest that spending growth will remain subdued.”

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