Canada-US yield spreads turn a corner on trade war bets
TORONTO, March 20 (Reuters) - The Canadian government bond market is unlikely to return to the record outperformance against U.S. bonds seen in February, as investors are now betting the trade war will slow the U.S. economy as well as hurt Canada's growth.
The Bank of Canada has been among the most aggressive of major central banks in the current easing cycle, cutting its benchmark interest rate by two and a quarter percentage points to 2.75% to support Canada's economy.
That led to the Canadian 10-year yield trading as much as 153 basis points below its U.S. equivalent in early February, the largest gap seen in LSEG data going back to 1994, but the spread has since rebounded to -125 basis points.
A negative yield spread indicates investors earn a lower return on Canadian bonds than on U.S. bonds if the investments are held until maturity.
A move to smaller spreads, including on shorter-dated bonds, could ease pressure on the Canadian dollar, which last month touched a 22-year low at 1.4793 per U.S. dollar, or 67.60 U.S. cents. Investors tend to favor higher yielding currencies.
"I think we've peaked," said Darcy Briggs, a portfolio manager at Franklin Templeton Canada. "The market assumed that whatever economy had the tariffs applied on (it) would be hurt, but now there is a growing realization that U.S. growth is actually set to come down considerably as well."
The Organization for Economic Cooperation and Development has forecast that U.S. economic growth will slow to 2.2% in 2025 and expects the economy to lose more steam next year. For Canada, the OECD sees growth slowing to 0.7% this year and next.
A decline in U.S. Treasury yields would likely be the main driver of smaller spreads as the market prices in a lower end-point for the Federal Reserve's easing campaign, said Robert Both, senior Canada macro strategist at TD Securities.
Canada's 10-year yield is "sitting much closer to fair value," Both said, forecasting the 10-year spread will hit -55 basis points by the end of 2026.
The BoC has said it would "proceed carefully" on further rate cuts given the need to consider upward pressures on inflation from the trade war. Canadian inflation heated up in February to an annual rate of 2.6% and that doesn't yet reflect the impact of tariffs.
New Canadian Prime Minister Mark Carney is expected to call a snap election within days, which could delay possible government economic support to counteract the impact of tariffs. Polls show the ruling Liberal Party in a tight race with the opposition Conservatives.
Regardless of who wins, analysts say that Canada has the fiscal room to respond to a crisis.
The Canadian government's latest projection shows the deficit at 1.6% of gross domestic product in the current fiscal year, much less than in the United States. The U.S. budget gap was 6.4% of GDP for fiscal 2024.
"Fiscal expansion is coming in one form or another," which would likely include spending on the military, infrastructure investment and tariff-related support for the economy, Jason Daw and Simon Deeley, strategists at RBC Dominion Securities Inc, said in a note.
Canadian bonds are unlikely to exceed their recent outperformance, the RBC strategists said.
"It would require a perfect storm of large and sustained tariffs without a fiscal offset and material Canada growth underperformance," they wrote.
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Reuters
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Pakistan likely to hike defence spending but slash overall budget in 2025-26
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Reuters
11 hours ago
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TRADING DAY London calling, stocks crawling higher
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What could move markets tomorrow? Opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the Trust Principles, opens new tab, is committed to integrity, independence, and freedom from bias.
Daily Record
17 hours ago
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Our handpicked Father's Day gifts on Amazon any dad will love for under £50
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You'll receive daily updates on breaking news as well as the top headlines across Scotland. No one will be able to see who is signed up and no one can send messages except the Daily Record team. All you have to do is click here if you're on mobile, select 'Join Community' and you're in! If you're on a desktop, simply scan the QR code above with your phone and click 'Join Community'. We also treat our community members to special offers, promotions, and adverts from us and our partners. If you don't like our community, you can check out any time you like. To leave our community click on the name at the top of your screen and choose 'exit group'. If you're curious, you can read our Privacy Notice. BOSS Bottled Unlimited Eau de Toilette, 100ml - £36.95, down from £84 No-one can ever go wrong with a new fragrance, and this is the perfect opportunity to bag a new bottle for him while making an incredible 56 percent saving. Hugo Boss is often a popular fragrance brand for everyone, and this particular "modern" and "energizing" scent is boasts notes of iced violet leaves, pineapple and sandalwood for an aroma that will suit any man, no matter his age. An electric shaver he can use in and outside of the shower is a must-have grooming essential, and this particular model uses 4D floating heads for a close shave across all contours of the face. Designed to effortlessly glide across stubble, leaving no irritation, it also offers a decent 1.5 hour battery life on a single, full charge. Not to mention that it comes complete with a travel pouch, ideal for when he is away on business trips or vacation. It may not be one of the fancier Nespresso machines, which can be fairly pricey, but this popular coffee machine offers a more affordable option for those looking to save pennies. Not only does the sleek, compact gadget offer versatile brewing, but this particular deal comes complete with boxes of pods for three rich and creamy coffees - Cafe Au Lait, Americano and Flat White. Looking for something a touch more sentimental? Then we think this unique glass clock is the perfect gift for anyone who wants to remind dad how much they mean to them. This glass keepsake uses Swiss quartz movement and has been crafted from a high quality, scratch resistant material that means it will stand the test of time.
