Surprise interest rate hikes from Canada and Australia suggest that larger markets may need to tighten further

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The Bank of Canadasurprising decision increase your prime rate June 7 sent ripples across global bond markets, adding another dose of uncertainty to the upcoming June 14 rate announcement. US central bank.

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Both the Canadian and Australian central banks surprised markets by raising rates last week, leading ka the collapse of global bonds and speculation that the Fed might follow suit. But the Fed has signaled loudly that it will hold this week, with markets placing the probability of a hold at 75 percent. Then it seemed even more likely May inflation on Tuesday at four percent, the lowest level in two years.

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But the Bank of Canada’s 25 basis point hike to 4.75 percent ended what had been a five-month hiatus, signaling to some that the economic winds are shifting and raising the potential for the Fed not to raise rates.

What happened?

The two-year Canadian bond yield rose more than 20 basis points after the Bank of Canada announcement.

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Derek Holt, head of capital markets economics at Scotiabank, said the central bank’s decision “has blown a foul odor into global bond markets.”

Avery Shenfeld, chief economist at CIBC Capital Markets, said that by not waiting until July and being less patient, the Bank of Canada probably took another step to the upside.

“Bond yields in both countries could see further upward pressure between now and September as markets appreciate the risks of subsequent hikes for some time and also feel the impact of the US Treasury’s supply surge as the government replenishes its cash position and debt ceiling agreement now reached” he said.

What did the Canadian hike signal?

Although the direct impact was limited, the end of the pause that began in January gave markets something of a reality check on the risks associated with the outlook for major central banks like the Fed, said Royce Mendes, head of macro strategy at Desjardins Capital Markets.

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Federal Reserve Board Chairman Jerome Powell speaks during a discussion at the Federal Reserve Board Building in Washington, DC.
Federal Reserve Board Chairman Jerome Powell speaks during a discussion at the Federal Reserve Board Building in Washington, DC. Photo by SAUL LOEB/AFP via Getty Images

“Market participants see the Bank of Canada’s return to rate hikes as a bit of a canary in the coal mine,” Mendes said, adding that the Bank of Canada’s move could be a leading indicator of what other central banks might do to contain inflationary pressures.

But Canada did not act alone. Stephen Brown, deputy chief economist for North America at Capital Economics, said the Reserve Bank of Australia’s walk last week against consensus expectations for a pause was also a major part of the reaction in global markets.

“It’s this sort of accumulating evidence that maybe central banks around the world need to do a little bit more to get inflation under control, which has had this effect on global markets,” Brown said.

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Is it unusual for global markets to react to a rate hike in Canada? Why is this time different?

Mendes said it’s somewhat unusual for markets to react so strongly to developments here in Canada. But he said the Bank of Canada has at times been a leader in changing the global narrative around monetary policy, and this could be one of those moments.

The Bank of Canada was certainly seen leading the sell-off in global developed market sovereign bonds immediately after the rate hike was announced, he added.

“Canada is typically a relatively small jurisdiction and so does not occupy much space in investors’ minds, but given that the Bank of Canada’s decision could have implications for other central banks, it is seen by traders as a potential turning point in central bank policy,” Mendes said.

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Although it is usually unusual for relatively small central banks to dictate global market movements to this extent, the Bank of Canada was one of the most aggressive central banks among advanced economies last year in terms of growth, he said. The Bank of Canada in July of last year added 100 basis points to shocks in global markets as well, as it signaled that all central banks would have to follow similar aggressive strategies, Brown added.

“There was no major effect, but it certainly shifted the investor consensus more towards the idea that the Fed will probably have to increase the pace again in July and certainly that rate cuts are likely to come a little later than originally expected,” he said.

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