Typically, when investors are looking at trends in the G7 realm of sovereign debt markets, there seems to be a sense that rates in general are all moving in the same direction. Sure, magnitudes can shift and spread relationships can narrow or widen on a more near-term or intermediate basis, but overall, the expectation is for yield levels to broadly move in tandem. Looking at trends thus far in 2017, market participants would discover that ‘all rates are not created equal’, and that varying trends have, in fact, occurred.
On the other side of the Atlantic, U.K. 10-year government yields have moved very little, and are down 10 basis points (bps) as of this writing. Meanwhile, on the ‘continent’, German 10-year rates have risen by 25bps.
UST & CAD 10-Year Yields
However, for the sake of this blog, we are going to focus more exclusively on developments in North America. Although expectations to begin the year were overwhelmingly looking for U.S. Treasury (UST) yields to increase in 2017, just the opposite has occurred. Indeed, the UST 10-year has experienced a decline of almost 20bps, despite the fact the Federal Reserve (Fed) has already raised rates twice this year, and appears poised to begin their balance sheet normalization process in the fourth quarter. It should be noted that the move in the UST 10-year has not been a one-way street to the downside, as the yield did spike up to 2.63% in mid-March before falling back down to the 2.25% area.
In Canada, the reverse has held true. As the accompanying graph illustrates, rate movements for the UST and Canadian (CAD) 10-year yields were exhibiting somewhat similar trading patterns throughout the first five months or so, but a visibly diverging pattern has emerged since. For the year-to-date, the CAD 10-year has witnessed a 20bps increase. However, since the 2017 low was printed on June 6th (1.39%), the yield has risen 53bps to 1.92%, and at one point crossed the 2% threshold to 2.06%, the highest point in almost three years.
The catalyst behind this upward move emanated from central bank policy considerations, as the Bank of Canada joined the Fed’s tightening ‘party’. Specifically, the Bank of Canada (BOC) first signaled their intentions to potentially tighten monetary policy in mid-June, and then followed up with an actual rate hike of 25bps on July 12th, the first increase since 2010. Once again, much like their central bank neighbor to the south, the BOC also mentioned that the “recent softness in inflation…to be temporary.” Unlike the U.S., the expectation is for another BOC rate hike by year-end with the implied probability for the December meeting being placed at 71.7%. For the record, the same gauge for the FOMC December gathering is at only 44.8%.
If the BOC is the next G7 central bank to continue on the rate hike path, CAD government yields could be susceptible to further upside in the months ahead, and depending on the timeline, for 2018 as well. Against this backdrop, Canadian fixed income investors may wish to dial down their interest rate sensitivity and focus more on the credit side of the ledger. In our opinion, the WisdomTree Yield Enhanced Canada Aggregate Bond Index ETF (CAGG), and the WisdomTree Yield Enhanced Canada Short-Term Aggregate Bond Index ETF (CAGS), offer solutions to help achieve such a reallocation. In addition, a CAGG/CAGS blend can also help to boost yield and reduce potential interest rate risk as compared to more traditional market-cap based approaches.
Unless otherwise noted, data source is Bloomberg, as of August 7, 2017.
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