20000331Canada bonds end down, lag US market substantially

TORONTO: Canadian government bonds ended sharply lower across the curve on Wednesday, underperforming the US market as offshore players reportedly dumped Canadian bonds, market watchers said.

"I heard there's been some selling outside of Canada," said one Toronto bond trader. "The Street seems to be long the market and suffering today," he added.

The Canadian benchmark long bond, due 2027, lost C$1.21 to C$129.10 to yield 5.848 percent.

In the US, the 30-year T-bond lost 1/32 to yield 5.977 percent. The negative yield spread between the two long bonds was at 12.9, from 20.1 at the previous session's close.

While Canada's underperformance of US Treasuries was most marked in the long end, the entire Canadian yield curve lagged behind the US

"Canada is a little weaker against the US," the trader said. "There's some selling of Canada against the US I think the Canadian market continues to struggle with liquidity, and in a falling market, it's difficult to attract new buyers."

Some of the pressure on North American bonds reflected a reassessment of the possibility that the US Federal Reserve might raise interest rates 50 basis points at its next policy-setting meeting rather than confining itself to 25, the trader said.

"I think the market's just pricing in a bit of premium in the event the Fed does go 50 at the next meeting," he said.

Larry Berman, chief fixed-income strategist at CIBC World Markets Inc., said Canada's acute underperformance was consistent with offshore selling of Canadian bonds.

"Typically, what happens when you get a big move in Canada versus the US is that you've got foreigners selling. We certainly haven't seen domestic clients sell heavily in the last few days, so that's our suspicion, though we haven't seen the flows," Berman said.

Widening credit spreads may have also contributed to the Canadian underperformance, he added. "When credit spreads are weak, or weaker, like they have been in the corporate markets recently, (and) the provincial markets and the corporate swap markets, Canadas tend to underperform, so that's another factor," he said.

The sell-off of Canada relative to the US also reflects the fact that Canadian yields had reached extreme lows against the US yield curve, with the negative spread on long bonds reaching more than 30 basis earlier this year, market watchers said.

"That's definitely been very close to an extreme that we've been in the last couple of years, and that's definitely a trigger for people to sell," Berman said.

Technical factors were also weighing on bonds on Wednesday, he added. "You've got some weak technicals. You haven't seen that in quite a while either," he said. The last time technicals were aligned so bearishly across the yield curve was last April, he added.

Bond markets have rallied so much in recent months and factored in so much anticipated good news they are now vulnerable to a significant pull-back, he said.

"Right now, I think the move's been quite excessive and I think we're going to correct some of that," he said. "I think what's happened in the US and in Canada is that we've rallied pretty strongly -- we're factoring in an awful lot of good news, and the market's not going to realise that in the coming months, so we are susceptible to a bit of weakness here."

Volumes were moderate on Wednesday, market watchers said. "(There's been) heavier trading than the last couple of days, but nothing remarkable," Berman said.

But the Toronto bond trader said bond markets may be buoyed by investment flows from ebbing stock markets in coming sessions.

"I caution getting overly bearish or overly short the index, because with the continued weakness in the NASDAQ, this could certainly cause further equity weakness down the road, and at that point I wouldn't want to be short any bonds," he said.

In supply news, the Toronto-Dominion Bank priced a C$750 million, 10-year bonds with five years of fixed interest payments with a coupon rate at 6.60 percent followed by five-years of floating payments, according to lead manager T.D. Securities Inc.

The bonds are callable on April 14, 2005, with final maturity on April 14, 2010. It was priced at C$99.807 to yield 6.646 percent, or 46 basis points over the 9 percent Government of Canada bond maturing in December 2004.

The short end outperformed the long end, pushing the negative yield spread between the two-year and 30-year bonds to 17.1 from 20.2 at the previous session's close.

Canada's two-year bond lost 10 Canadian cents to C$99.45, for a yield of 6.019 percent.

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

In economic news, the final revision for fourth-quarter gross domestic product growth will be released in the United States on Thursday, while Canada releases GDP growth for January on Friday.

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