The recent surge in long term interest rates raises many issues regarding fiscal responsibility, and nowhere is this more evident than in a comparison between Canada and United States. Very much in the background is the fact that Canadian interest rates have not fully tracked the surge in U.S. rates this year. Across the entire yield curve spectrum, Canadian rates are well below their U.S. counterparts (Figure 1). Significantly, Canada’s 10-yr yield is fully 55pbs below that of the U.S. rate, having widened from a spread of 20bps only a year ago. The Canadian bond market is not marching to the U.S.' tune and much of that can be explained by the different approaches to fiscal management in the two countries.

Figure 1 Comparison of Yield Curves

In response to the 2008 crisis, the U.S. Federal government deficit simply ballooned as it dealt with an unprecedented bailout of the Wall Street banks, a collapse of the housing and mortgage markets and widespread unemployment (Figure 2). Overall, U.S.  government deficits reached as an apex of 13% of GDP, winding down steadily, but slowly, to where is stands today at around 5% of GDP.

Figure 2 U.S. and Canadian General Government Deficits as a Percent of GDP

In contrast, Canada, did weather the 2008 financial storm far better. Even with the collapse of the oil prices in 2014, Canadian deficits remained very low under the Conservative government. With the election of the Liberals, the deficits have increased. However, Canadian authorities maintained fiscal discipline and the resulting deficit position was just 1.1% in 2016.

But long-term interest rates are very much a reflection of future borrowing requirements. Here is where the two countries diverge further. The U.S. tax reform bill and supplementary budget requirements are expected to add $1.5-2.0 trillion to the Federal government total debt position over the next ten years. The U.S. Federal government will continue to run deficits around 6% of GDP for another decade at least.

The Canadian Federal government will bring down its 2018-19 budget in March and that there are no significant changes in the overall deficit are expected. Finance Minister Morneau has resisted pressure to lower corporate taxes to match those of the United States. Federal government deficits are expected be in line with the previous budget, around 3% of GDP.

As the two countries move further apart on the issue of government deficits, we can expect that the interest rates spreads will, at least, be maintained, and possibly widen further as the U.S. bond market copes with net increases in bond issuances.