Canadian bonds outperformed the rest of the global debt market in May as investors trimmed bets the Bank of Canada will raise interest rates in the third quarter, burnishing the appeal of the nation's fixed-income assets.
Bank of America Merrill Lynch's Canada Broad Market Index gained 1.62 per cent through May 30, beating the 1.13 per cent return by the firm's Global Broad Market Index. The outperformance is the widest this year. The Bank of Canada held its policy rate at 1 per cent yesterday, where it's been since September.
"A lot of hedge funds had set up for rising interest rates early in the year, expecting a stronger economy and an aggressive central bank," said John Braive, a fund manager at CIBC Global Asset Management in Toronto, who oversees about C$35 billion (Dh132 billion) in Canadian fixed-income assets. "As time went by it became obvious that the Canadian economy would be cooling and the bank came out with more dovish statements."
The outperformance by Canadian bonds may soon end after policymakers said yesterday the central bank will raise rates "eventually" as the economy recovers. Odds of a 25 basis-point increase at the September meeting rose to about 30 per cent after the statement was released, from 18 per cent the day before. The odds of an October jump are about 56 per cent, according to data compiled by Bloomberg.
The yield on Canada's benchmark two-year bonds rose four basis points to 1.54 per cent Tuesday after the bank statement. The yield was as high as 1.75 per cent on May 6. The Canadian dollar also posted its biggest gain in six months, rising 0.9 per cent, as investors speculated rates will move higher.
"Markets are taking this as a relatively more hawkish than expected statement," Derek Holt, an economist at Bank of Nova Scotia in Toronto, wrote in a note to clients. "That's relative to having largely priced out rate hikes through to year end."
Holt predicts the central bank will stay on hold until October.
The broad Canadian bond index gained 2.09 per cent in 2011, outpacing the global index's 1.94 per cent advance through May 30. Canada's benchmark Standard & Poor's/TSX Composite Index has climbed 2.68 per cent since January 1, having declined 1 per cent in May.
Elsewhere in credit markets, the extra yield investors demand to own the debt of Canadian investment-grade corporations rather than the federal government widened to 132 basis points, or 1.32 percentage points, from 128 basis points on April 30, according to a Bank of America Merrill Lynch index. Yields fell to 3.77 per cent on May 31, from 3.93 per cent on April 30.