Skip to main content

The U.S. bond market continued to send warning signs about the health of the economy on Wednesday, but investors in Canada shouldn’t reach for the panic button just yet. Unlike its U.S. counterpart, signals from the Canadian bond market have an uneven track record in predicting trouble ahead.

“How useful is Canada’s yield curve as a predictor of recessions? Not very, is the bottom line,” concluded a report from Bank of Nova Scotia.

The yield curve compares the yields on long-term bonds with short-term bonds, and it has been flat for some time in both Canada and the United States, as long-term bond yields have been declining over the past four months.

But the U.S. yield curve inverted on Friday, when three-month U.S. Treasury bills yielded more than 10-year Treasury bonds, and that triggered a wave of commentary from economists and market watchers who believe that inversions often predict recessions.

In the United States, the yield curve inverted prior to the past seven recessions, including the Great Recession of a decade ago.

The Canadian yield curve has also been inverted since Friday, adding concerns that this economic indicator may be suggesting that the Canadian economy is also facing a rough patch ahead.

No wonder stock markets have been uneasy in recent days. The S&P 500 fell nearly 2 per cent on Friday. The benchmark index wavered again on Wednesday: It was down as much as 1.1 per cent in midday trading, ending the day off 0.5 per cent as the inversion deepened amid the latest batch of discouraging global economic news.

The U.S. trade deficit narrowed in January, owing to a larger-than-expected decline in imports that may be signalling weaker domestic demand. The yield on the 10-year U.S. Treasury bond fell to a 15-month low, reflecting the growing belief that the U.S. Federal Reserve will not raise its key interest rate this year. The Canadian benchmark 10-year bond also fell to its lowest level since 2017, hovering just above 1.5 per cent.

“There’s two conflicting stories here. One is that the Fed and global central banks are keeping rates on hold, and that’s creating a very supportive backdrop,” said Gennadiy Goldberg, an interest rate strategist at TD Securities in New York.

“The other story is they are doing this because they expect weakening and that the next move from here is a global recession,” Mr. Goldberg said.

Indeed, concerns are global. The European Central Bank said Wednesday it could further delay raising its key interest rate. New Zealand’s central bank left its key interest unchanged, and signalled that its next move may be a rate cut, adding to concerns about the health of developed markets.

In China, profits from industrial firms declined 14 per cent in January and February, compared with the same two-month period a year ago, according to Capital Economics.

But Bank of Nova Scotia noted that the Canadian bond market is one area where investors may want to include some historical perspective.

Derek Holt, head of capital markets economics at Scotiabank (with assistance from Alena Bystrova), took two different definitions of a recession – back-to-back quarterly declines in gross domestic product and the C.D. Howe’s more comprehensive definition – and then looked at various parts of the Canadian yield curve to see if inversions were accurate predictors.

For the 10-year bond and 3-month bill inversion, which is causing all the fuss in the U.S. bond market right now, the recession signal has suffered a weak track record.

The inversion successfully signalled a recession in the early 1990s. But it gave false positives (it inverted without a subsequent recession) in 1986 and 2000. It also failed to predict a recession in 2015 (that is, there was no inversion).

The inversion prior to the financial crisis is also open to debate: The inversion occurred in 2006, or well ahead of Canada’s brief recession, Mr. Holt noted.

What about when the two-year bond yields more than the 10-year bond? This part of the yield curve has a similar history: It predicted a recession in the early 1990s; it inverted in 1986, 1998 and 2000 without a subsequent Canadian recession; and it failed to see the oncoming recession in 2015.

“The curves are worse predictors of the Canadian business cycle than the U.S. curves,” Mr. Holt said in a note.

One thing is clear, though: The U.S. bond market is rattling stocks and Canadian equities are hardly immune.

Canada’s Curve Is Not A Great

Recession Predictor

Ten-year yield minus 90-day yield

5%

4

3

2

1

0

CD Howe Recession

-1

Recession

Defined as

back-to-back quar-

terly declines in

gross domestic

product

-2

-3

-4

1982

‘86

‘90

‘94

‘98

‘02

‘06

‘10

‘14

‘18

the GLOBE AND MAIL, SOURCE: Scotiabank

Economics; Bank of Canada; CD Howe

Canada’s Curve Is Not A Great

Recession Predictor

Ten-year yield minus 90-day yield

5%

4

3

2

1

0

CD Howe Recession

-1

Recession

Defined as

back-to-back quarterly

declines in gross

domestic product

-2

-3

-4

1982

‘86

‘90

‘94

‘98

‘02

‘06

‘10

‘14

‘18

the GLOBE AND MAIL, SOURCE: Scotiabank Economics;

Bank of Canada; CD Howe

Canada’s Curve Is Not A Great Recession Predictor

Ten-year yield minus 90-day yield

5%

4

3

2

1

0

CD Howe Recession

-1

Recession

Defined as back-to-back

quarterly declines in gross

domestic product

-2

-3

-4

1982

‘86

‘90

‘94

‘98

‘02

‘06

‘10

‘14

‘18

the GLOBE AND MAIL, SOURCE: Scotiabank Economics; Bank of Canada; CD Howe

With files from Reuters

Follow related authors and topics

Authors and topics you follow will be added to your personal news feed in Following.

Interact with The Globe