For a glimpse of the outlook for the Canadian bond market, look at how 2025 is starting. Prime Minister Justin Trudeau announced he would step down and that Parliament would be suspended until March 24, adding political uncertainty at a critical time. A shift to a more fiscally conservative government could ripple through the economy for years.
Jason Daw, head of North America rates strategy at RBC Capital Markets, asserts that the implications for the bond market are benign: “Anything on the political side would play out after the Bank of Canada has already completed the policy easing cycle this year.” He says a Conservative government promises more business-friendly policies to help mitigate Canada’s severe underperformance in business investment and productivity (both domestically and relative to the US), “setting the stage for improved investor sentiment.”
Even with the added political uncertainty, many analysts are optimistic about the Canadian bond market in 2025. The economic backdrop is hospitable to bonds, with growth weakening and inflation tamed toward the Bank of Canada’s 2% target. That’s likely to lead to more interest rate cuts and a favorable environment for declining bond yields and rising prices.
Another positive can be found in the divergent path the Canadian economy is taking from the United States, with the Bank of Canada cutting interest rates more aggressively than the US Federal Reserve. This has helped Canadian bonds outperform their US counterparts—a trend analysts expect to continue in the new year.
However, the dominant trend will likely be the economic backdrop that leads the Bank to continue its push to lower interest rates. “Fixed income usually produces decent returns in an easing cycle,” explains Daw. “2025 should be a self-reinforcing cycle between macro and policy that leads to lower bond yields, steeper curves, and government of Canada [bonds] outperformance versus US Treasuries.”
Is This a Good Time to Buy Canadian Bonds?
Daw predicts additional Bank of Canada rate cuts will drive continued solid bond returns: “The bond market is underestimating how far the Bank of Canada can cut rates in both our base case (slow growth/disinflation pressures) and a trade war scenario.”
These rate cuts may be increasingly crucial, since the economic recovery remains fragile. Over the past two years, the Canadian economy has struggled as high interest rates collided with highly leveraged households, ongoing anemic business investment, and declining commodity prices. A trifecta of headwinds suggests below-trend growth will persist in 2025, with higher-than-normal downside risks.
Amid this challenging environment, David Stonehouse, senior vice president and head of North American and specialty investments at AGF Investments, says the current Canadian bond market offers a yield in the upper 3% range, an attractive alternative to cash equivalents. “Canadian bond yields have been trading in a broad range for two and a half years, and the Canadian bond market has delivered an annualized return in the 4.5% range over that period,” he says.
Normally, when the central bank cuts rates, long-term bond yields tend to fall. However, Carl Gomez, chief economist and head of market analytics at CoStar, contends that since these yields have remained somewhat uncharacteristically elevated, the extra reward for taking risks, such as buying stocks or corporate bonds is relatively small. “Investors should not be banking on recent rate cuts to help drive up their returns, but only help to preserve them,” he says.
Stonehouse says that yields being in the 3%-5% range over the past couple of years are the most attractive they’ve been in the last 20 years. “These yields are high enough to provide a cushion during a recession or equity bear market,” he notes, highlighting bonds’ diversification benefits, as they are expected to “deliver solid positive returns in such an environment, offsetting stock market declines.”
Opportunities to Buy Bonds Outside Canada
However, some market watchers see better opportunities elsewhere. “With yields lower in Canada—for example, the 10-year Government of Canada bond yield is more than 100 basis points lower than US Treasuries—we see attractive opportunities across global fixed-income markets which offer investors the ability to lock in attractive levels of income,” says Rachel Siu, head of Canadian fixed-income strategy at BlackRock.
She favors opportunities in global sectors, with securitized assets, European credit, and selective US high-yield and emerging markets being particularly attractive. “Now is the time to lock in global yields at these levels,” she says. That’s especially the case for short-term and medium-term bonds.
“Canada bonds outperformed Treasuries in 2024 due to a weaker economy, lower inflation, and aggressive central bank easing,” wrote BMO Economics senior economist Sal Guatieri in a note to investors. “Barring a trade war, it could lag this year as the [Canadian] economy picks up.” He forecasts that after rising 12 basis points to 3.23% in 2024, the 10-year rate will decline modestly to 3.00% by year-end.
Risks to the Bond Market Outlook
Multiple unknowns are swirling around the Canadian bond market. They include US-Canada politics, US economic growth, possible tariffs, US monetary policy, and the Canadian dollar. Canadian investors should also be cautious about inflation returning, though the risk remains low.
Gomez points to the uptick in long-term bond yields as a bellwether for global inflation risks from potential protectionist US trade policies. “Long-term interest rates have resisted falling with the Bank of Canada cuts and even have some upward bias,” he argues. “Since the Canadian yield curve remains slightly inverted [short-term bonds yielding more than long-term ones], the Bank of Canada has room to cut further to loosen financial conditions a bit more.”
Poor business investment, productivity, and a shrinking population due to government restrictions on immigration could stymie Canada’s economy. “Disappointing economic growth would be positive for Canadian bonds,” Stonehouse says, alluding to how investors tend to flock to safe assets like bonds amid uncertainty.
Political Uncertainty and the Bond Market Outlook
Another prominent threat to the bond market comes from the upcoming elections. Stonehouse notes that Conservative Party leader Pierre Poilievre “has made threats about interfering with the Bank of Canada, which would not go over well in the bond market.”
The threat of US tariffs under the incoming Trump administration also looms, potentially impacting several areas of the economy. Steep taxes on Canadian goods could “disrupt economic activity, which should be favorable to bond markets,” Stonehouse explains.
Meanwhile, any uptick in inflation, which is currently tame, could spell bad news for the bond market. “Inflation has picked up slightly in the US in the last few months, and coupled with a rebound in Canadian and global economic activity, could unleash a modest reacceleration in inflation later this year, which would be unwelcome for Canadian bonds,” cautions Stonehouse.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.
