Canada's long-term government and provincial bonds had a rough August, as yields climbed across the board. According to BMO Capital Markets, the Government of Canada's 30-year bond yield reached its highest level since 2008, a stark reminder that the era of ultra-low interest rates is firmly in the rearview mirror.
BMO noted that the move was broad-based, with yields rising across the entire curve. The 10-year government bond yield rose by 8 basis points, while the 30-year yield climbed 10 basis points. For investors holding long-duration bonds, this is a painful development: when yields rise, bond prices fall, and the longer the maturity, the more sensitive the price is to yield changes.
Why long-term yields are climbing
The rise in long-term yields reflects a combination of factors. Investors are demanding higher compensation for the risk of holding bonds over a longer period, partly due to concerns about inflation and government borrowing needs. The Bank of Canada, the country's central bank, has also been a factor. At its latest meeting, it held its policy rate steady, offering no immediate relief to bond markets. BMO expects the central bank to remain on hold for now, which means short-term rates are likely to stay elevated, but the market is pricing in a different path for long-term rates.
Long-term yields are not directly set by the central bank; they are determined by supply and demand in the bond market. When investors expect higher inflation or stronger economic growth, they typically demand higher yields to compensate for the erosion of purchasing power over time. This has been a recurring theme in 2024, as economies have shown resilience and inflation has remained sticky.
What it means for bond investors
For everyday investors, the rise in long-term yields is a double-edged sword. On one hand, it means that new bonds issued today offer higher coupon payments, which can be attractive for income-seeking investors. On the other hand, anyone holding older bonds with lower coupons is seeing the market value of those bonds decline. This is particularly true for long-duration bonds, such as 30-year government bonds, where even a small yield increase can translate into a noticeable price drop.
Provincial bonds have also been affected, as they tend to move in tandem with federal government bonds. Investors who hold provincial bonds may see similar price declines, though provincial bonds typically offer a slightly higher yield to compensate for the additional credit risk.
For those with bond funds or ETFs, the impact is similar. A rise in yields can lead to negative returns in the short term, even if the underlying bonds are held to maturity. This is a key reason why financial advisors often recommend that investors with a shorter time horizon avoid long-duration bonds.
Broader market context
The move in Canadian bond yields comes amid a global trend of rising long-term interest rates. In the United States, the Federal Reserve has also been grappling with inflation, and its policy decisions have ripple effects on Canadian markets. The Fed's recent hints at a pause have provided some relief to equity markets, but bond yields remain elevated.
In Canada, the TSX has been supported by a tech rally, but elevated bond yields can weigh on stock valuations, particularly for growth companies that are sensitive to discount rates. The TSX has also been flat as higher yields offset gains in oil and gold.
The rise in long-term yields also has implications for the broader economy. Higher borrowing costs can dampen consumer spending and business investment, which could slow economic growth. However, it can also be a sign that investors are optimistic about the future, as higher yields often accompany expectations of stronger growth.
What to watch next
Investors will be watching the Bank of Canada's next moves closely. If the central bank signals that it will keep rates higher for longer, long-term yields could continue to climb. Conversely, if economic data weakens and the bank pivots to rate cuts, yields could fall, providing some relief to bond prices.
For now, the message from the bond market is clear: the era of cheap money is over, and investors need to be prepared for a world where yields are higher and bond prices are more volatile. As always, diversification and a clear understanding of your own time horizon are key to navigating these conditions.
