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Canadian bonds higher as investors flee equities

TORONTO: Canadian government bonds ended higher on Friday as bond markets functioned like an ark for imperilled investors, providing a refuge from the vicious storms sweeping over equity markets.

While much of the pressure stemmed from inflationary data and fears of higher interest rates in the U.S., which would normally drive bond markets down, the flight to quality flows abandoning stock markets were enough to lift bonds higher, market watchers said.

The Canadian benchmark long bond, due 2027, gained 56 Canadian cents to C$131.29 to yield 5.715 percent.

In the U.S., the 30-year T-bond gained 8/32 to yield 5.778 percent. The negative yield spread between the two bonds was at 6.3 basis points from 5.0 at the previous session's close.

It was reported early in the session that the U.S. consumer price index rose 0.7 percent in March, outpacing the expected 0.5 percent climb. The core index jumped 0.4 percent, the biggest jump in more than five years. Analysts had called for a 0.2 percent rise.

Bonds plummeted after the news, but bounced back quickly as stock market futures pointed to a weak opening on equity markets.

Although bond markets remained volatile for the rest of the session, safe-haven flows kept the overall tone positive, market watchers said.

"I think it's pretty straightforward story today. At least for bonds, obviously the weakness we're seeing in equity markets has totally swamped the negative from U.S. CPI," said Doug Porter, senior economist at BMO Nesbitt Burns.

"I think it's quite clear that the CPI was unambiguously bad news for the bond market, and under normal circumstances we probably would have seen quite a steep selloff in bonds today, but these are not normal circumstances," Porter said.

The Toronto Stock Exchange Composite 300 Index closed down 491.90 points to 8473.51, a record loss in points.

But the inflationary pressures implicit in the March CPI report also mean there are limits to the bond market's ability to strengthen, market watchers said.

"I think there's a limit as to how much the bond market can benefit, because if today's CPI is more than just a flash in the pan, then bond yields will probably ultimately head higher rather than lower," Porter said.

The positive impact of the flight to quality flows won't be able to sustain bond market gains on a longer term basis, since any presumption that the U.S. Federal Reserve won't increase rates because of the stock market plunge is unjustified, said Andrew Spence, senior economist at Deutsche Bank Securities.

"I think the message coming along is at this point is bonds are continuing to view a selloff in the stock market as meaning the Fed doesn't have to be tightening, which I think is certainly not the impression I would get from the retail sales in the U.S. on Thursday and CPI data," he said.

"We have a bearish view on interest rates for good, old-fashioned reasons that we're late in the cycle, and even if productivity growth has moved up...rates have to go up for cyclical reasons," Spence said.

Nesbitt's Porter agreed that further rate tightening is likely in the works despite the stock market debacle.

"I still believe this is not the end of the Fed tightening cycle. I think there still is work to be done," he said.

Canadian bonds put in a mixed performance against the U.S. Treasury curve on Friday.

Trading volumes remained moderate despite the overall turbulence in financial markets, with bond information system CanPx reporting a total of C$449 million of trading in eight benchmark bonds.

The Canadian yield curve steepened slightly, with the negative yield spread between the two-year and 30-year bonds moving to 5.7 basis points from 6.7 at the previous session's close.

Canada's two-year bond gained 9 Canadian cents to C$99.95 for a yield of 5.772 percent.

In money markets, the three-month when-issued T-bill yielded 5.39 percent, down from the previous session's close at 5.40 percent.

Statistics Canada will release Canadian Consumer Price Index data for March on Monday.-Reuters