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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.