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Canada bonds up sharply, long end continues to lead

TORONTO: Canadian government bonds ended substantially higher on Thursday, with the long end substantially outpacing the rest of the curve even after relinquishing some of its early gains.

Although the Bank of Canada raised its benchmark bank rate 25 basis points to 5.25 percent on Thursday, market watchers said the biggest influence on Canadian bonds was the US Treasury market, where the long also surged higher.

"It's primarily following the US bond market, which obviously has been up a lot, and it's cooled off little bit," said Frank Hracs, head of fixed-income research at T.D. Securities Inc..

The Canadian curve's gains were substantial before the Bank of Canada announced the rate increase at its 9:00 a.m. (14:00 GMT) policy window. The market strengthened further after the widely expected move, but surrendered some of its gains later in the session.

The Canadian benchmark long bond, due 2027, gained C$1.63 to C$125.41 to yield 6.080 percent.

The US 30-year T-bond gained 57/32 to yield 6.153 percent. The negative spread between the two long bonds was at 7.3 basis points, from 11.6 at Wednesday's close.

The Canadian 30-year bond had achieved gains of C$2.25 in early trading, but eased off those levels as trading progressed.

"Things are extremely volatile, and it's really hard to know when the market might settle down," Hracs said.

The strength in the US long bond follows Wednesday's announcements of decreased supply and impending buybacks in the US, analysts said.

"The catalyst is the announcement of the Treasury buying back longer term bonds, and that has forced some developments such as further short covering, (and) it has perhaps forced some investors to extend term in fear of underperformance," Hracs said.

"Obviously the move has been quite dramatic in the last day. It's hard to know at this stage there the real value is on a long-term Treasury bond, and in turn for a long Canada bond," Hracs said. "It still remains unclear as to where the long bond in the US should really settle, once the forces of panic really start to dissipate."

Although market players remain concerned about additional tightening from the US Federal Reserve in the wake of its 25-basis-point move on Wednesday, interest rate fears were pushed into the background by intense activity in long bonds, he said.

"I think the market remains quite concerned about the Fed, and if anything has elevated the risks of future Fed tightening. That seems to be lost in the shuffle of this market action in the long bonds," Hracs said.

The Canadian curve lagged behind the US in most maturities. The huge outperformance in the long end resulted in further flattening for the Canadian curve, intensifying the inversion of the 2-year to 30-year curve that first surfaced on Wednesday. Canada's 2-year bond was up 9 Canadian cents at C$98.43, for a yield of 6.173 percent.

The three-month when-issued was at a yield of 5.19 percent, down from Wednesday's close at 5.25 percent. In supply news, the Government of Canada announced on Thursday that it will auction C$2.8 billion of 5-year bonds on February 9. The Bank of Canada's minimum bid will be C$420 million.-Reuters