Bond Market Betting Canadian Interest Rates Unchanged on September 8, 2010

For the first time since Mark Carney and the Bank of Canada raised Canadian interest rates on July 20, bond traders are now betting that Canadian interest rates will remain unchanged when the BOC makes its interest rate announcement on September 8, 2010.

With bond yields moving inversely to prices, Canada’s 2-year bond yielded 1.245%, from 1.288% while the Canadian 10-year bond yield was 2.896%, from 2.924% on Friday, August 20, 2010.

According to Bank of Nova Scotia data from the overnight index swap market, probabilities show a 62% chance that the Bank of Canada will keep its rate unchanged at 0.75% on Sept 8. This is up from below 40% earlier this month.

Bank of Montreal data indicates a 60% chance of rates remaining unchanged from around 45% a week ago.

According to a Reuters article on August 23, 2010:

With further evidence last week that the domestic economy is losing steam, including soft inflation and leading indicator figures for July, most of Canada’s primary dealers on Friday called for a pause in the bank’s rate hike campaign in the fourth quarter, but stuck to forecasts for an increase at its next scheduled policy announcement on Sept. 8.

Market expectations of a September hike, however, as reflected in yields on overnight index swaps, have diminished to about 38 percent, as calculated by Reuters.

Eric Lascelles, chief Canada macro strategist at TD Securities in Toronto said, “The market is now gambling that a hike is less likely than a pause, that is a notable shift in the last couple of days.”

The overnight-indexed swaps market is considered one of the most reliable indicators of market sentiment on rate increases.

On Monday it was estimating a 40% probability that the bank will raise rates on Sept 8, that’s down from a 50% probability on Friday, and a near certainty last month.

With the recent weakness in the Canadian economy including soft inflation numbers and a declining dollar on a 5-week low, swap market sentiment and bond market expectations are now trending towards the BOC leaving rates unchanged on September 8.