America’s Impact on Canadian Interest Rates

Many don’t realize the influence the U.S. has on Canadian interest rates.  Over the long-run, rates in both countries move together pretty closely.

US-Canadian-Bond-Yields

The biggest reason for this, of course, is the economic link between our two countries. The correlation between U.S. and Canadian GDP growth, for example, is 75%.

The correlation between Canadian and U.S. 5-year government bond yields over the last 10 years is over 88%.

US-Canadian-Bond-Yield-Correlation

The odds therefore suggest that if U.S. yields rise long term, Canadian yields will rise too, and that’s concerning.

America is digging a giant debt hole for itself, and someday, it might not be able to climb out.

Bond guru, Bill Gross, notes that…

Five more years of (10% of GDP) deficits will quickly raise America’s debt to GDP level to over 100%, a level that the rating services – and more importantly the markets – recognize as a point of no return.

At some point, investors may start questioning the “risk-free” reputation of U.S. treasuries and demand significantly higher rates to buy U.S. debt.  It’s within reason that these upset investors (“bond vigilantes” as the Wall Street Journal calls them) could push U.S. long-term rates up 3-4% or more.

Interest compounding would then add further fuel to the fire because as yields rise, it takes more government borrowing to pay interest on the growing debt.  In a way, it’s not unlike a giant government-sanctioned Ponzi scheme.

In any event, while U.S and Canadian bond yields can and do diverge, America’s debt addiction could very well exert upward pressure on Canadian yields in time.

That’s a good reason to live within your means now…and pay down all the debt you can while rates are still low.

  1. Nice article, but this advice could be too late for a lot of people out there getting large mortgages to outbid each other. Best thing they can hope for is massive inflation to eat away their debt.

  2. Just wondering, how would massive inflation be a good thing?
    Wouldn’t that cause higher interest rates, which are a bad thing?

  3. Excellent explanation. It’s too bad our government can’t spell this stuff out before it matters. Now it’s too late for many, but still worth knowing for those who’ve been prudent.

  4. Massive inflation is a good thing for debtors who can increase their income to pay off long term debts with low interest. (Just think about those people who bought houses in the 70s for 50k and think how easy it would be to pay it off now) Obviously, it’s a bad news for variable rate short term debtors.

  5. Not if incomes do not increase relative to inflation. We might be in situation of stagflation, which is inflation coupled with little to no growth. And with massive deficits at all levels of gov the last thing will be large increases in salaries. Ontario is looking at freezing the public sector wages.

  6. The real story here is how much more Canadians are vulnerable to inflation than the US, with over 95% of Canadian mortgage rates renewing within the next 5 years. Compare this with American debtors, who by majority are locked into a rate for 25,30,35 years.
    I’d be interested to know the history of term offerings in both countries – I suspect that somewhere along the line Canadian long-term debt (25 plus years) was unmarketable to investors and so 5-10 year terms were promoted instead. Unfortunately, while short term debt may be great for some, its probably a very bad idea for others – akin to portfolio allocation based on risk preference.
    The onus for this impending nightmare falls squarely on the Minister of Finance and CMHC.

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