Canadian Interest Rate Futures

At 9am (eastern time) on September 8th, the Bank of Canada will make an announcement regarding the overnight target interest rate, which is currently 0.75%. The 3-month Bankers’ Acceptance futures market currently has the following quotations:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 10 SE 98.895 98.900 98.890 0.000 16669
+ 10 OC 0.000 0.000 98.795 0.020 0
+ 10 NO 0.000 0.000 98.785 0.020 0
+ 10 DE 98.850 98.870 98.850 0.010 19389
+ 11 MR 98.760 98.770 98.750 0.010 12911
+ 11 JN 98.670 98.690 98.650 0.020 6078
+ 11 SE 98.550 98.570 98.530 0.020 3172
+ 11 DE 98.400 98.430 98.400 0.110 363
+ 12 MR 98.270 98.310 98.270 0.100 262

A September and December contract at around 98.85-98.9 is projecting that there is a higher than average chance of a 0.25% rate increase this upcoming meeting, and then no further rate increases for the rest of 2010.

The market is likely going to be correct with this – I anticipate a statement that will state that domestic growth in Canada is quite good, but there remains significant risks outside the country that might affect Canada’s domestic economy.  A 1% short term rate, historically, is still very stimulative.

3-month corporate paper is yielding 0.98% on September 7th and 3-month T-Bills are yielding 0.78%.

In the last decade, the previous low bank rates were 2.25% in early 2002 and in the middle of 2004.

The main impact of the sum of these interest rate increase decisions is that the yield curve will be slightly less steep – traditionally banks make money by borrowing short and lending long.  So when rates were at 0.25%, they could borrow money at that rate, and then lend it out (the ultimate risk-free loan would be to the Government of Canada, which has a 10-year bond yield currently of 2.95%).  You would then skim the difference (2.7%) as profit, which is nearly risk-free.

By increasing interest rates, spreads shrink somewhat.  Assuming the Bank of Canada does raise rates to 1%, the spread will shrink to 1.95% for 10-year money which is still profitable, but not quite as profitable as it was at lower rates.

People with sensitivity to short-term rates (e.g. variable rate mortgages, margin balances in margin accounts) will feel the impact of this increase most directly.