Government bonds in Canada and the United States surged on Wednesday, in some cases breaking through levels last seen during the devastating 2008 financial crisis, a sign that investors see more trouble ahead for the North American economy.
As worries grow that the United States may be sliding back into recession, investors have flocked to government debt as a relative haven from economic turmoil.
Expectations have all but vanished for the interest rate increases that the Bank of Canada had signalled were on the table as recently as mid-July. The shift reflects how quickly the economic outlook has shifted from modest optimism to deep concern.
The yield on the 10-year U.S. Treasury bond fell below 2.11 per cent (yield moves in the opposite direction to price), closing in on its low in 2008. In a $24-billion (U.S.) Treasury auction of 10-year bonds, investors snapped up the offerings at record-low yields, underlining the intense demand for the securities even after Standard & Poor's cut the U.S. government's credit rating by one notch last week.
Yields on Government of Canada 10-year and 30-year bonds have also fallen sharply since the end of July and are now at record lows. In the case of the 30-year bond, the yield fell below 3 per cent for the first time ever.
"We're feeling the gravitational impact of the U.S.," said Michael Gregory, an economist at Bank of Montreal.
The Federal Reserve did little to assuage the growing anxiety about the state of the U.S. economy in its monetary policy statement on Tuesday. These concerns have rippled across the border.
As well, there is tremendous uncertainty over whether the U.S. can get its fiscal house in order, even after Washington agreed earlier this month to raise its debt ceiling.
"When you add it up, I think markets are undergoing a dramatic reassessment," said David Madani, an economist at Capital Economics.
Mr. Gregory noted that U.S. inflation risks are higher than they are in Canada, reflected in the fact that three Federal Reserve officials voted on Tuesday against a promise to keep key interest rates exceptionally low until at least mid-2013. This might be driving Canadian yields to fall more sharply than U.S. yields.
Mr. Madani believes yields could move even lower should inflation expectations decline. Right now, long-term inflation expectations in Canada are running between 2 per cent and 3 per cent a year.
"We've seen a lot of volatility over the past few days," he said. "This could all bounce back. But then again, if this slowdown is real – and we think it is – there is scope for yields to fall even further."
David Berman