Investors are advised against resisting central banks. That doesn’t mean they won’t try. 

The Bank of Canada left the benchmark rate unchanged last week, after a series of cuts earlier this year. Governor Tiff Macklem lowered rates by a quarter point in both September and October, which, coupled with matching cuts in January and March, put the policy rate at 2.25 per cent, a percentage point lower than at the start of the year.

Yields on longer-term bonds are headed in the opposite direction. The rate on 30-year government debt reached nearly 3.9 per cent in the second week of December, compared with about 3.3 per cent at the start of the year, per Bank of Canada data. Ten-year yields also were on course to end the year higher, despite the central bank’s four rate cuts. An analysis of historical rates since 2021 suggests the markets have not resisted central bank guidance so persistently in at least a generation.  

It’s unusual for policymakers to lose all control of the rate trajectory, adding another layer of uncertainty at a moment when Prime Minister Mark Carney plans to reorient the economy by borrowing vast amounts of money.

“We’re migrating into another fixed-income environment,” said Philippe Ouellette, a senior portfolio manager at Montreal-based Fiera Capital. 

Macklem’s struggle to influence the long end of the curve—or bonds maturing far into the future—isn’t a comment on the Bank of Canada, or even Canada itself. He’s up against a force that is bigger than his institution: Donald Trump’s convention-defying approach to economic policy. The U.S. president’s apparent comfort with massive budget deficits, his aggressive use of import tariffs and his disregard for the Federal Reserve’s independence have caused bond investors to ratchet up the risk premiums they require to become creditors of an erratic superpower.

The disconnect between the Bank of Canada’s policy rate and long-term rates is largely being driven by expectations that high U.S. inflation will persist, said Randall Bartlett, deputy chief economist at Desjardins. Washington’s expanding deficit is driving a larger volume of bond issuance to fund government spending, which in turn puts upward pressure on long-term rates because of supply-and-demand effects. That’s more than enough to keep U.S. rates high, Bartlett said. 

By comparison, Canadian inflation is under control. Ottawa is doing its share of borrowing, but nothing like what the Trump administration will need to do to finance its spending plans. “It is so amusing to me as an American to see how Canadians have freaked out about your debt-to-GDP projections,” said Jack Manley, a global market strategist at New York-based J.P. Morgan Asset Management. “We would kill for your numbers with where we are right now.”   

However, because U.S. treasuries are the world’s preferred risk-free asset, the price at which they are bought and sold tends to set the tone for interest rates globally. That’s especially true for Canada, which might be more intertwined with the U.S. than any other country. There’s a gap between Canadian and American long-term rates that favours Canada, but Canadian borrowing costs are still rising despite its relative fiscal stability and this year’s rate cuts. 

“We’re importing a lot of these higher yields at longer term maturities from the U.S.,” Bartlett said.

It’s unclear whether Canadian decision-makers have fully absorbed the implications of what’s happening in the debt markets. Borrowers typically try to match the maturity of their debt to their funding needs—for example, a government or corporation might issue a 10-year bond to finance a decade-long infrastructure project. But higher rates at the long end of the curve are pushing borrowers to lend disproportionately at the short end, where rates are lower. “The longer end is more stable, so you want some at the longer end,” Macklem said in testimony at the House of Commons finance committee in November. 

Bartlett said he expects the gap between long-term yields and policy rates to persist in the coming years. As advanced economies boost defence spending and run larger deficits, they will be issuing more bonds—increasing the global supply of government debt and keeping upward pressure on long-term rates. 

Canada might be able to mitigate the pain of higher rates by maintaining a relatively stable macro environment, but it won’t be able to avoid it, assuming the current dynamic continues. There’s no obvious reason it won’t. Canada is expected to hold its current policy rate through the next year, with a potential hike in 2027, according to Claire Fan, a senior economist at Royal Bank of Canada, as better-than-expected GDP and labour data leave little justification for further easing. Meanwhile, the U.S. is expected to deliver one last rate cut next year before hitting pause, Fan said, as slow economic growth, rising inflation and a still labour market limit the Fed’s room to ease further.

There’s a silver lining. Higher rates are problematic for borrowers, but for investors, the bond market is getting interesting again. To fight the Great Recession, central banks pinned interest rates near zero and left them there for longer than anyone expected. They repeated that playbook during the COVID-19 recession, and then ratcheted up interest rates to catch up with post-pandemic inflation. None of this was good for bond investors, but Ouellette said he senses the mood is starting to change. Risk-averse investors who have been sitting on a pile of cash are starting to consider Canadian bonds as a way to earn a “very attractive” return.  

“From an investor point of view, this is great for bonds,” Ouellette said. “We’re very excited.”