Canadian bond markets pricing in one more rate cut this year

Fixed-income investors who are used to Canadian and U.S. markets moving in tandem may have to change their playbook next year, says Dustin Reid, chief strategist, fixed income with Mackenzie Investments.

He said conditions point to the front end of the Canadian curve moving lower in 2026, while the front end of the U.S. curve moves higher.

“We could be seeing slightly different pathways for the Canadian curve and the U.S. curve. And I think investors should just keep that in mind as we move forward,” he said. “The kind of a one-stop shop [mentality] may not actually hold here for the short- to medium-term.”

According to Reid, markets are pricing in different equations for the two economies.

“At a minimum, the beta is going to be not very high. The beta is going to be lower than historical averages, or historical correlations,” he said.

Looking at the short and long end of both curves, he likes the Canadian short end best.

“I have the most confidence being long the front end of the Canadian curve,” he said, citing high Canadian household debt and continuing malaise in the housing and labour markets.

“I think that’s going to be potentially challenging here for the Canadian economy,” he said, and if the Bank of Canada moves rates below what the market has priced in, that could make the front end of the curve look very attractive.

“The Bank of Canada thinks that neutral interest rates for the economy is a range somewhere between 2.25% and 3.25%. If the economy evolves as I expect that it will, the bank would probably need to get into accommodative territory below 2.25%. And the market’s not pricing that,” he said.

“It probably won’t be great from an economy perspective, but from a markets perspective, there are definitely opportunities in the front end of the short-term Canadian sovereign curve of the fixed-income market.”

Central bank independence

Reid said another thematic to watch is central bank independence, which looks to be under threat in the U.S., where the Trump administration wants to install hand-picked governors.

That is a development that is not restricted to the U.S., Reid said. In Japan, the incoming Prime Minister has argued for more government input on monetary policy. And in the U.K., former Prime Minister Liz Truss has suggested the Bank of England will inevitably become more intertwined with government policy.

“It just underscores where I think the world is moving,” he said. “It’s difficult for me to see, in two or three years that we’re going to see more central bank independence, globally. That seems very unlikely. I think the pendulum has really swung towards less central bank independence.”

If economic performance does not justify rates going as low as politically motivated central banks set them, it could have a dramatic impact on bond prices, credit market spreads and equity valuations.

“So this is a significant topic. We don’t really have a lot of experience or data as to how that experiment might end — in a good way or a bad way. The jury is out,” he said. “I suspect this will be something that we’ll be covering, as journalists, as strategists, as investors, for a number of years ahead.”