Short-term bond yields are down sharply this morning in both the U.S. and Canada, largely reversing Friday’s moves, after U.S. President Donald Trump said he was halting strikes on Iranian energy infrastructure. The comments followed what he said were productive weekend talks between the U.S. and Iran.
The Canadian 2-year yield, sensitive to central bank policy moves, was down 15 basis points to 2.92% in late morning trading. The 2-year U.S. Treasury yield was down about 8 basis points.
Similar yield drops are being seen across the pond. Britain’s 2-year bond yield is down about 21 basis points.
The moves come as traders trim their bets on possible central bank rate hikes in the months ahead.
Implied interest rate probabilities in overnight index swap markets now suggest the Bank of Canada will hike interest rates a total of 50 basis points by the end of this year, according to Bloomberg data. A quarter point rate hike is nearly priced into markets by this July.
On Friday, markets had priced in 75 basis points of Bank of Canada tightening by the end of this year, which would equate to three quarter-point rate hikes.
The Bank of Canada’s current overnight rate is 2.25%. While the bank only moves the overnight rate in quarter-point increments, markets price in a much less rigid rate when setting bets on future policy rates.
Right now, traders are positioned for an overnight rate of 2.74% by December 9.
Several economists on Friday were expressing doubt about these markets bets for aggressive rate hikes this year.
Economist David Rosenberg, for instance, wasn’t mincing words on what he thought in a Friday email to the Globe:
“The fact that the swaps curve and the front end of the bond market have gone ahead and priced in rate hikes in Canada may go down as one of the most bizarre financial events to have ever happened in this country. It is beyond preposterous to think that the Bank of Canada will be hiking rates in an environment where a sub-one percent growth backdrop is precipitating an ever widening disinflationary output gap. Given the rising slack in the labour market all this oil price shock will accomplish is a contraction in real incomes and spending as it hits the proverbial wall in the weakening labour market. The only way the Bank of Canada would ever raise rates in this sort of environment is if there was evidence that the price shock would feed into wages and that simply is not going to happen. I classify this as the mother of all misplaced knee-jerk reactions. And when all is said and done interest rates will come down to levels that will be lower than they would have been without this energy shock which is a de-facto a disinflationary tax on domestic demand.”
U.S. rate futures on Friday began to price in the possibility of an interest-rate hike later this year after the Fed and other central banks last week kept the rates on hold. Markets had priced in a 95.9% chance of no hike for the Fed’s April meeting as of Monday morning.
“The question is whether all this repricing is warranted,” said Antonio Gabriel, global economist at BofA Securities, in a Monday morning report.
“More disruptive scenarios for global growth may be underpriced, and growth concerns could prevail, tilting some central banks to look through the shock.”
With a report from Reuters