"We expect long bond yields will continue drifting up through at least the early summer, with 10-year Treasuries peaking around 5.3%. Upward pressure is also being applied by offshore central bank tightening (e.g., ECB, Bank of Japan) along with concerns about the financing of America's massive current account deficit and a gammy greenback. Given the above factors and the asymmetric risk that the Fed might have to tighten more aggressively, we judge that the risks to our bond call are skewed to the upside.

We look for the Fed to be in a holding pattern through the turn of the year, and cut rates a cumulative 50 bps before mid-2007, as GDP growth slides deeper to the mid-2% range. In anticipation and in the wake of Fed easing, bond yields should drift back down as the yield curve steadily steepens. The low point for 10-year yields looks to be around 5.1% by the middle of next year.

Canada long bond yields should rise in concert with their U.S. counterparts during the months ahead, with a strengthening Canadian dollar and a persistent paucity of supply permitting modest outperformance (to beyond -65 bps in the 10-year sector). As U.S. bond yields drift lower through the turn of the year, we judge Canadian bonds will follow suit, but lag a bit owing to less negative spreads in the overnight sector and some retreat in the Canadian
dollar from its early-2007 peak."

Download BMO May report on Bonds