Bond Market's Newest Bet: Buy America, Sell Canada on Rate Hikes
Bloomberg Jun 29, 2017
• Canadian 10-year futures block trade is second-largest ever
• U.S.-Canada yield spread collapses to narrowest since October
An unusual trade across America’s northern border is starting to become a more prominent fixture in the market for sovereign debt.
It’s a straightforward play: simultaneously purchase Ultra 10-year Treasury futures and sell contracts for similar-maturity Canadian debt. It’s a bet that U.S. bonds will outperform as the Federal Reserve slows down its pace of interest-rate increases, while the Bank of Canada appears to be considering a hike as soon as next month.
What’s striking to traders is the size of the wagers. Each leg of Wednesday’s transaction, which sent Canadian bond futures tumbling, represented about $820,000 of risk per basis point. The 9,098-contract Canadian block is the second-largest ever, trailing only a trade in March 2008, according to Shane Quinn, a spokesman for TMX Group.
Targeting the yield spread between U.S. and Canadian debt, which reached the narrowest since October, isn’t as common as trading the difference between Treasuries and bunds. German securities serve as a proxy for the euro area and react to European Central Bank policy decisions. The emergence of these cross-border flows may signal that traders are trying to get ahead of a global effort to tighten monetary policy after years of unprecedented stimulus.
Investors on Wednesday ramped up bets on a rate increase in Canada after BOC Governor Stephen Poloz said “rates are of course extraordinarily low,” and after rate cuts in 2015, the central bank needs to consider pulling back on stimulus efforts. The market-implied probability of a hike next month is about 69 percent, according to overnight indexed swap data compiled by Bloomberg.
Those remarks sent 10-year Canadian yields higher by five basis points, to 1.61 percent, making them among the worst performers among developed-market sovereign debt. The spread with Treasuries dropped to as little as 58 basis points, the lowest since Oct. 19.
Last week saw the same U.S.-Canada trade, with equally weighted futures blocks also with a September expiration, though for about half the duration risk as Wednesday’s transaction. That means the total position stands to gain or lose $1.3 million per basis-point move.