It’s Never Paid Less to Lend to Canada Compared With the U.S.

July 27, 2015 Bloomberg

by Ari Altstedter and Lananh Nguyen

It’s never been less attractive to lend money to Canada relative to the U.S.

Yielding just 1.46 percent, 10-year Canadian government bonds pay about the least relative to similar-maturity U.S. Treasuries since Bloomberg began collecting data in 1989. While economists estimate data this week will show U.S. gross domestic product expanded at a 2.5 percent annual rate in the second quarter, speculation is mounting that Canada’s economy fell into recession.

The diverging prospects helped drive the loonie to an almost 11-year low against the dollar on Friday. With traders expecting the Federal Reserve to raise its benchmark interest rate before the end of the year and signs that Canada may need to cut its further, the interest-rate advantage luring capital south may only grow.

“If I’m an investor and I can get an extra percentage point buying a five-year Treasury compared to a five-year Canada, I’m tempted to buy that Treasury,” Sal Guatieri, an economist at Bank of Montreal, said by phone from Toronto Friday. “U.S. debt markets are simply more attractive than Canadian markets.”

Oil Plunge

The extra yield investors can get buying benchmark 10-year U.S. bonds compared to Canada’s rose to a record 79 basis points July 20, and two days later the premium on the U.S. five-year note reached 99 basis points, its own record, data compiled by Bloomberg show.

The spikes came as crude oil, Canada’s largest export, plunged below $50 per barrel for the first time since April, and only a week after the Bank of Canada cut its main interest rate for the second time this year, saying the economic damage from the earlier leg down in oil was more severe than first thought.

With data already showing the Canadian economy shrank 0.6 percent between January and March, the economic forecasts the Bank of Canada released with its rate cut call for a 0.5 percent contraction in the three months ending in June.

A technical recession is defined as two consecutive quarters of economic contraction.

Rate Cut

Across the border, economic prospects in the U.S. are looking up for the rest of 2015.

The Conference Board’s index of leading indicators, a measure of the outlook for the next three to six months, rose 0.6 percent in June, according to figures from the New York-based group Thursday. Sixty-two economists surveyed by Bloomberg forecast GDP growth accelerated to a 2.5 percent pace from April through June.

Traders are already pricing in a chance for a second rate cut in Canada, while growing more bullish in the last month that the U.S. will raise its own before year end, Bloomberg calculations based on trading in overnight index swaps show.

One place where traders expect the rate differential to play out against Canada is the currency market, where the loonie, as the Canadian dollar is known for the image of the aquatic bird on the C$1 coin, fell to to C$1.3103 per U.S. dollar on Friday, the lowest on an intraday basis since September 2004.

“The U.S. and Canadian economies have never been more desynchronized than they are right now,” David Doyle, a strategist at Macquarie Capital Markets, said by phone from Toronto Friday. “It means the loonie is just going to keep weakening.”

Further Losses

Hedge funds and other large speculators are betting on further losses. Wagers for the Canadian dollar to fall further against its U.S. peer outnumbered those for gains by 43,568 contracts last week, the most since March 2014, data from the Commodity Futures Trading Commission showed Friday.

“It’s just a widening interest-rate-differential in favor of the dollar,” Karl Schamotta, director of foreign-exchange research and strategy at Cambridge Global Payments in Toronto, said by phone Tuesday. “The big thing here is that if the Bank of Canada stays on hold for a prolonged period of time and we see aggressive tightening in the U.S. at the same time, that’s going to drive the Canadian dollar down.”

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