Canada yield curve may steepen after Federal Reserve hikes U.S. rates

Mon Dec 14, 2015 6:16pm EST
 
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By Fergal Smith

TORONTO Dec 14 (Reuters) - Canada may see higher bond yields and a steeper yield curve as the U.S. Federal Reserve begins to hike rates, according to market players, weighing on the economy while raising borrowing costs for consumers and businesses.

The U.S. central bank is widely expected to raise benchmark interest rates on Wednesday for the first time since June 2006, lifting the federal funds rate from zero to 0.25 percent.

The Bank of Canada on Dec. 2 kept its key policy rate steady at 0.50 percent, but the market is leaning toward another rate cut after crude prices fell further.

Higher borrowing costs will add another headwind to an economy hit by the oil price shock and offsetting the boost from planned fiscal stimulus by the new Liberal government.

The most sensitive part of the curve in Canada is going to be the 10-year maturity, according to Andrew Kelvin, senior fixed-income strategist at TD Securities, as the Bank of Canada's dovish stance caps yields for shorter-dated maturities.

The steepening in Canada's yield curve may gather momentum if forecasts for more Fed hikes are borne out. Besides Wednesday's anticipated hike, the median projection of Fed policymakers in September on the projected path of interest rates was 1.375 percent by end-2016 and 2.625 percent by end-2017.

That would entail 125 basis points in tightening next year, roughly two rate hikes more than implied by the market, assuming the Fed moves in 25-basis-point increments.

Likely flattening in the U.S. curve is not expected to play out in Canada, said Mark Chandler, head of Canadian fixed income and currency strategy at Royal Bank of Canada, pointing to the differing economic performance in the two countries.   Continued...