TORONTO: A recent rise in Canadian long-term bond yields is a signal the economy needs less support than it did in 2020, strategists say, as investors become more confident that a successful rollout of COVID-19 vaccines will eventually boost activity and inflation.
The jump in yields, which tracks a similar development in the US bond market, could provide Canadian policymakers with a reason to dial back historic levels of support for the economy, reassuring credit rating agencies alarmed by record deficits.
“It definitely signals more positive times ahead,” said Benjamin Reitzes, Canadian rates and macro strategist at BMO Capital Markets. “It’s a general belief that the economy is going to return to something a bit more normal.”
Canada’s 10-year yield has surged nearly 50 basis points this year to 1.15%, an 11-month high, while the market’s measure of inflation expectations has climbed to 1.8%, its highest level since May 2018.
Annual inflation accelerated to 1.0% in January, Canadian data showed on Wednesday.
The Bank of Canada has signalled it would reduce the bond purchases it has been making to bolster the economy during the pandemic as it gains confidence in the strength of the recovery. Growing economic confidence could also propel Prime Minister Justin Trudeau’s government to shift its agenda from one centred around bracing workers, families and businesses during the crisis to one focused on tackling the country’s soaring debt load.
Canada, which lost one of its coveted triple-A credit ratings last June, has forecast the federal budget deficit will hit a historic C$382 billion ($301 billion), or 17.5% of GDP, in the current fiscal year ending in March. Trudeau’s Liberal government is expected to deliver its 2021-2022 budget in early spring. “We are moving away from the emergency conditions, and so with that you get the market being a bit more upbeat on growth and also at the same time saying we aren’t going to need the same policy supports that we had in the real depths of all this,” said Derek Holt, vice president of capital markets economics at Scotiabank.
While the US bond market is also signalling better economic times ahead, the Federal Reserve is not yet planning to cut back on its bond purchases or raise interest rates, saying it will tolerate inflation running above its 2% target for a time.
In addition to sending a signal about the economy’s growth prospects, higher long-term rates could boost banks’ profit margins, all the more so because short-term rates, which are more sensitive to central bank policy, are currently stuck near zero. Banks often fund their lending with short-term borrowing or bank deposits.
Rising bond yields could also reduce the appeal of stocks with traditionally higher dividend payouts, such as utilities and real estate investment trusts.