Canada Yield Curve Disinverts With Fed and Macklem Eyeing Cuts

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(Bloomberg) -- Canada’s benchmark two-year yield briefly dropped below the 10-year for the first time in more than two years, as traders looked ahead to Federal Reserve cuts and Bank of Canada Governor Tiff Macklem made dovish comments to the Financial Times.

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Canada two-year notes dropped as low as 2.862% on Monday, the lowest level since June 2022 and down about 150 basis points since late May.

Falling yields and the disinversion of the curve reflect the rapid change in expectations for short-term interest rates in North America. Economists, markets and central bankers are increasingly convinced that a two-year campaign of aggressive monetary tightening has largely snuffed out inflation pressures.

As a result, there’s less of a need for borrowing costs to keep restricting growth. Swap markets show traders expect the Fed to cut by at least a quarter-point on Wednesday, with about a 50% chance of a half-point cut.

The Bank of Canada has already cut rates three times since June, bringing the benchmark overnight rate to 4.25%, and officials have signaled more to come. Economists see mounting weakness in the labor market, and some of them are calling on policymakers to start making bigger moves to bring down borrowing costs.

Macklem told the Financial Times in an interview that there’s “enough slack in the economy” to get back to the 2% inflation target and policymakers “don’t want to see further or sustained weakness in the labor market.”

He also reiterated that it “could be appropriate to move faster” on interest rates. Speaking to reporters on Sept. 4, Macklem said policymakers had also discussed a scenario in which the economy and inflation surprise to the upside and the bank reduces the pace of easing.

Traders in overnight swaps have also upped their bets for a larger-than-normal reduction at the central bank’s Oct. 23 decision. Swaps markets put the odds of a 50-basis point cut at around 50%.

Markets expect rates in Canada to fall to about 2.5% by July of next year — more than 50 basis points lower than they were pricing a month ago.

“Unfortunately for bears, there is no mystic in the curve besides the monetary policy cycle,” Fred Demers, investment strategist at BMO Asset Management, said in an email.

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The yield curve only signals that policy is set to loosen, and is “mostly removing the knife on the throat” of the economy, he said.

Canadian inflation data are due Tuesday at 8:30 a.m. Ottawa time. Economists surveyed by Bloomberg expect yearly price pressures to fall to 2.1%, which would be the lowest since February 2021.

The country’s unemployment rate unexpectedly jumped to 6.6% in August, and third-quarter growth is expected to be lower than the central bank’s forecasts.