Canada-US Bond Yield Gap Set to Widen Amid Slowing Economy

Canada's 2-year government bond yields are sending a different signal than those in the US, according to David Rosenberg of Rosenberg Research. The Canadian economy is further along in a slow-growth, lower-inflation cycle, with core inflation running at 1.7% annually compared to 2.6% in the US. Canada's real economy has also been shrinking by 0.1%, while the US grew 2.7%. Rosenberg expects the gap between Canadian and US 2-year bond yields to widen from around -140 to -160 basis points, driven by Canada's output gap.

The output gap is estimated at roughly negative 1.3% of GDP, which suggests that the economy is running below its potential. This setup could lead to a decline in Canadian 2-year bond yields, with Rosenberg predicting they could drift towards 2.3% over the next six months. However, this outlook may be challenged by market expectations for further Bank of Canada tightening and potential new US tariffs.

The implications of this scenario are significant for lenders, as the 2-year Government of Canada yield is seen as a proxy for where the Bank of Canada policy rate is headed over the next couple of years. A decline in yields could reduce upward pressure on interest rates, benefiting borrowers but potentially hurting savers.