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Canada bonds buoyed by sinking stock markets

TORONTO: Canadian government bonds ended sharply higher across the curve on Thursday as investors abandoned sinking equity markets and scrambled for the safety of fixed-income assets.

"The US and Canada are doing well. Equity markets are down and bond markets are up," said one Canadian bond trader.

Equity markets across North America were swept under a mounting tide of losses as the session progressed, with the technology-heavy Nasdaq dropping 4 percent, or 186.76 points to end at 4457.91. The Toronto Stock Exchange 300 composite index ended down 308.14 points at 9394.02.

At one point late in the session, the TSE index was down 404.26.

The Canadian benchmark long bond, due 2027, gained 87 Canadian cents to C$130.04 to yield 5.791 percent.

In the US, the 30-year T-bond gained 1-13/32 to yield 5.876 percent. The negative yield spread between the two long bonds ended at 8.5 basis points, from 12.3 at the previous session's close and 31.8 on March 6, as the Canadian market lagged substantially behind the US in virtually all maturities.

Some of the decline relative to the US comes after excessively high valuations for Canadian bonds in recent weeks, the trader said. "We were very expensive to the States for the last two, three weeks. At some point you knew it was going to come back, and it's been coming back in the last few days," the trader said.

The correction may have cheapened the Canadian long bond a little too much relative to its US equivalent, he added. "It made no sense when it was 25 (basis points) through, and it's probably a little on the cheap side at these levels," he said.

Although it's possible that the yield on the Canadian 30-year bond may go higher than the yield for its US equivalent, it won't likely hold there, he added. "It wouldn't surprise me if you had the spread north of the US, but I don't know if it would stay there," the trader said.

James Davis, vice-president and portfolio manager of global fixed income and currencies at Royal Bank Investment Management Inc., agreed that stock market losses were the main impetus behind the bond market's climb on Thursday.

"That is primarily what it is, a stock-market related trade," Davis said.

But a number of other positives are aligned behind the bond market and will continue to support it in coming sessions, he added.

"I think there's a number of factors driving the bond market. The first, of course, is the supply. And also, I think, there seems to be a bit more comfort, at least at the longer end of the curve, that the Fed is no longer behind the curve (on inflation)," Davis said. "Couple those things with the stock market activity, and the bonds look pretty good."

Davis attributed some of the Canadian market's underperformance against the US to the domestic flight to quality trade in the US, where concerns about the agency debt continue to benefit Treasury issues and undermine corporate bonds and other "spread product."

"I think some of the concerns with what's going on with the agency issues in the US..that's certainly having an impact on all spread product," Davis said.

Debt issued by agencies chartered by the US federal government such as Fannie Mae and Freddie Mac weakened again amid fears the government will not stand behind their issues if the agencies were to default.

Trading volumes in Canadian bonds appeared to be fairly light on Thursday morning, with the bond information system CanPx reporting a total of C$330 million of trading in eight benchmark bonds by the end of the session.

The bond market may be susceptible to some pullback in coming sessions despite the positives after its recent substantial gains, some market watchers said.

"I think, in the near term, we've probably moved a little bit too much, too quickly," Davis said.

News that revised US gross domestic product growth was 7.3 percent in the fourth quarter had little sustained impact on North American fixed-income markets, since analysts had expected a robust figure.

The short end outperformed the long end, pushing the negative yield spread between the two-year and 30-year bonds to 15.4 basis points from 17.6 at the previous session's close.

Canada's two-year bond gained 13 Canadian cents to C$99.60, for a yield of 5.945 percent.

In money markets, the three-month when-issued T-bill yielded 5.34 percent, up from the previous session's close of 5.33 percent.

Canadian gross domestic product growth for January will be released on Friday. A consensus forecast prepared by Reuters is calling for a 0.3 percent increase from the previous month, slightly lower than the 0.4 percent climb recorded in December.

A strong domestic GDP report would strengthen the currency and be indirectly helpful for bonds, some market watchers said.-Reuters