The spread between Canadian and U.S. two-year government-debt yields is the widest since 2007 before Wednesday’s Bank of Canada meeting, a sign traders are paring expectations for interest-rate hikes this year.
Canada’s two-year obligation yielded 1.74 per cent Tuesday, compared with 2.55 per cent for its U.S. counterpart, for a gap of 81 basis points. Since Thursday, the difference has widened 7 basis points, after data showed Canada’s economy practically came to a halt last quarter.
The spread “is telling us that the market is less convinced of a BoC hike,” said Bipan Rai, head of North American foreign-exchange strategy at CIBC. “The market is looking for some form of acknowledgment of weaker-than-expected growth in the statement.”
Rai expects the loonie to weaken to C$1.36 per U.S. dollar over the coming month, recouping its year-end levels, from C$1.33 now. The depreciation would be contingent on weaker data, with all eyes on employment figures due Friday. The report is expected to show Canada’s labour market barely added jobs in February, following an unexpected surge of 66,800 in January.
The recovery in oil since the turn of the year and optimism surrounding U.S.-China trade talks had some market strategists betting the BOC wasn’t done tightening, after five hikes since mid-2017. But deteriorating economic data have traders shifting gears, sending the probability of a rate hike by July below 15 per cent, from about 26 per cent a month ago.
Focus on Guidance
BOC Governor Stephen Poloz and fellow policy makers are expected to keep rates on hold Wednesday, and traders’ focus will shift to the forward guidance. At its last meeting, the bank said the “policy interest rate will need to rise over time,” with a pace dependent on developments in oil and housing markets and global trade policy, according to a Jan. 9 statement.
“April seems like a more likely point for Poloz to abandon forward guidance altogether, as they’ll have an updated forecast by then,” said Andrew Kelvin, senior Canada rates strategist at Toronto Dominion Bank. “Still, there is a material risk that they give up on future rate hikes at this month’s meeting.”
Either way, he expects the two-year yield spread to widen further in the next few months. Investors should go long Canadian fixed-income assets in the front end or the belly, either outright or versus Canadian 30-year bonds or Treasuries, he said.