Excess Demand for 5-year Bonds (and Swaps): A Bad Omen for Canada’s Economy?

Since mid-June, Canadian 5-year bonds have outperformed other parts of the yield curve which may signal serious trouble ahead for the housing market and the economy. Moderate and aggressive managers may choose a contrarian view in 5-year rates, a slope trade in the 5-10 year segment, or a more conservative swap spread widening trade.

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    September futures contracts face first notice August 29 and first delivery September 2, following the Labour Day holiday. The holiday timing prompts early roll trades as managers and dealers attempt to close September contracts ahead of schedule, creating optimal liquid roll dates between August 25 - 27. The holiday period typically creates more volatile roll pricing as market participation shifts. Additionally, futures have been trading rich to bonds since July, further complicating execution. Timing options will be active for CGZ and CGF contracts this quarter.
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    After a 43-basis-point tightening over 13 months, Canadian 5-year swap spreads are showing signs of stabilizing, opening up new opportunities in fixed-income markets. This tightening reflects changes in risk appetite, government bond issuance, and mortgage market hedging practices. While economic uncertainties persist, current spread levels suggest a potential for mean reversion, particularly when compared to historical trends. This market development provides tactical entry points for relative value strategies.