Closing Market Update: Bond Market Suggests Bank of Canada Will Cut Rates

Market Updates | Written by CEP News | Aug 01 08 22:04 GMT |

(CEP News) - Canadian interest rate derivatives continued to rally in shortened trading on Friday, suggesting growing conviction the Bank of Canada will lower rates as soon as September. In the U.S., equities closed and Treasury yields were down slightly. The U.S. dollar made modest gains and crude finished above $125 per barrel. Market watchers are puzzled by the rally in Canadian fixed income. The bond market posted its best week since February and derivative pricing suggests the Bank of Canada is preparing to cut rates. Economists say the market is offside. Following soft GDP figures on Thursday, bankers' acceptance futures contracts (BAX) at the Montreal Exchange have undergone an extraordinary rally. The Sept BAX is yielding 3.125%, implying a 58%-70% likelihood the BOC will cut rates at the Sept. 3 meeting. The December contract is fully priced in for one quarter-point cut by the end of the year and suggests a 40% chance of another. "It's all out of whack. None of the guys on the street understand it," a BAX trader in Montreal said. "Everyone on the desk is scratching their head," another strategist in Toronto said. Some suggest a short-covering rally is underway, but other markets are pointing in the same direction. Overnight index swaps are pricing in a 23% chance of a BOC cut in September and are fully priced in for lower rates by year end. The cash market has also experienced a strong rally bringing two-year yields well below the 3.00% overnight target. Still, few economists are predicting the Bank of Canada will follow the market's lead. "We would need some major bad economic news for the Bank of Canada to cut in September. It's not impossible for December but we think the BOC will stay put for quite a while," said Mathieu D'Anjou, economist at Desjardins Securities. Yields on two-year Canadian government bonds were down 6.0 bps to 2.89%, with five-year yields down 4.8 bps to 3.20%, 10-year yields down 4.7 bps to 3.66% and 30-year yields down 2.7 bps to 4.07%. The December 08 BAX contract was up 5.0 ticks to 97.05 and the September 09 contract was up 0.015 to 96.875. In the U.S., the main news came from the jobs and automotive sector. A small upside surprise in the U.S. employment figures for July temporarily boosted the U.S. dollar, Treasury yields and equity futures, but sentiment later reversed. Nonfarm payrolls fell by 51k in July against a decline of the 75k expected. It was the seventh straight month of job losses. It was a bad day for auto manufacturers. It started with General Motors reporting a $15.5 billion second-quarter net loss compared to a profit of $784 million in the same quarter a year ago. Later, year-over-year auto sales figures for March were released. Chrysler sales fell 29%; GM sales fell 26%; Toyota sales fell 12%; Ford sales fell 15% and Honda sales fell 1.6%. "We expect the second half of 2008 will be more challenging that the first half as economic and credit conditions weaken," Ford's marketing chief Jim Farley said in a statement. U.S. two-year yields were down 1.7 bps to 2.49%, with five-year yields down 2.1 bps to 3.21%, 10-year yields down 1.0 bps to 3.94% and 30-year yields flat at 4.57%. The Eurodollar March 09 contract was down 3.0 ticks to 96.89. The yield curve was steeper, with the 10/2-year spread up 0.5 bps to 144.17 bps. The payrolls report inspired a spurt of trading that quickly sputtered out. Total cash volume was reportedly at 65% of normal, traders said. "Treasuries rallied early in the morning in anticipation of a horrific payrolls number, sold off sharply after nonfarm payrolls failed to match the worst fears, and then rallied back to finish slightly up on the day. Monthly car sales were horrific," wrote Benjamin Cheng, fixed income strategist at UBS. Even as U.S. auto sales slumped, Canadian sales of vehicles surged 5% compared to the same month last year, and are up 2.7% year to date, DesRosiers Automotive Consultants Inc. said. Toronto's S&P/TSX composite index closed down 96 points to 13497, the Dow Jones industrial average closed down 52 points to 11326, the S&P 500 closed down 7 points to 1260 and the Nasdaq closed down 15 points to 2311. On the month and the week, the Dow was virtually flat. The TSX lost 1.1% in July after a 6.7% decline in June. However, Canadian stocks finished the month on a strong note as the TSX gained 0.7% on the week after seven consecutive weeks of losses. On Friday, the Canadian dollar was down 0.0030 to 0.9732 against the U.S. dollar (1.0277 USD/CAD). The U.S. dollar briefly touched 1.0300, but traders said it was defended by an options barrier that expired at 10 a.m. EDT. On the month, the Canadian dollar fell 0.0076 against the U.S. dollar and lost 1.0% on a trade-weighted basis. "Like its commodity-related peers, CAD weakened amid softening oil prices, particularly in the second half of July," wrote currency strategists at Morgan Stanley in a research report. On Friday, the U.S. dollar was down 0.20 to 107.72 against the yen and the Dollar Index was up 0.214 to 73.441. The U.S. dollar gained 0.4% in July, according to the Fed's trade-weighted index. The euro was down 0.0055 to 1.5548 against the U.S. dollar, down 0.0011 to 1.5978 against the Canadian dollar, up 0.0012 to 0.7877 against the pound sterling and was lower by 0.90 to 167.48 against the yen. The pound sterling was down 0.0100 to 1.9742 against the U.S. dollar and down 0.0043 to 2.0289 against the Canadian dollar. WTI crude oil was up $1.07 to $125.15. The front month gold contract at the Chicago Board of Trade was down $3.80 to $918.60 per ounce. All data taken at 4:15 p.m. EDT. By Adam Button, abutton@economicnews.caThis email address is being protected from spam bots, you need Javascript enabled to view it , edited by Sarah Sussman, ssussman@economicnews.caThis email address is being protected from spam bots, you need Javascript enabled to view it CEP Newswires - CEP News © 2008. All Rights Reserved. www.economicnews.ca The Copying, Broadcast, Republication or Redistribution of CEP News Content is Expressly Prohibited Without the Prior Written Consent of CEP News. A copy of CEP News disclaimer can be found at http://www.economicnews.ca/cepnews/wire/disclaimer.