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Canadian and U.S. government bond yields jumped on Friday, with the benchmark U.S. 10-year note surging to nearly three-year highs, as the market grappled with high inflation and increasingly hawkish central bank commentary. The TSX and S&P 500 closed higher, but the Nasdaq - which is particularly sensitive to rising bond yields - closed lower.

The Canadian dollar saw its ninth consecutive day of gains, its longest winning streak since August 2016, ending the week above 80 cents US.

Closely followed five-year bond yields in Canada - influential in the setting of fixed mortgage rates - took out their 2018 peaks and hit their highest levels since 2011. The five-year was fetching 2.503% by late afternoon, up 21 basis points for the day.

Canada’s 2-year yield soared 19.5 basis points to 2.337%, its highest level since November 2018.

Bank of Canada deputy governor Sharon Kozicki hinted on Friday that a half-percentage point interest rate increase may be on the table for the central bank’s upcoming rate decision in mid-April.

In her first speech since joining the central bank’s governing council last summer, Ms. Kozicki said that the central bank was “prepared to act forcefully” to bring high inflation under control.

“I expect the pace and magnitude of interest rate increases and the start of [quantitative tightening] to be active parts of our deliberations at our next decision in April,” she said. Quantitative tightening refers to the central bank shrinking its holdings of government bonds.

“The reasons are straightforward: inflation in Canada is too high, labour markets are tight and there is considerable momentum in demand,” she said.

Her comments follows Bank of Canada governor Tiff Macklem saying in early March that the bank is not ruling out a 0.5 percentage point rate increase instead of the usual 0.25 percentage point increase – something that hasn’t happened since May, 2000.

The Canadian dollar strengthened to its highest level in more than two months against the greenback amid the comments and a further rise in oil prices. The loonie was trading 0.4% higher at 1.2477 to the greenback, or 80.15 U.S. cents, after touching its strongest intraday level since Jan. 20 at 1.2471. For the week, the currency was up 1%.

Money markets expect Canada’s central bank to raise interest rates to about 2.5% this year to fight inflation. Earlier this month, it hiked for the first time since October 2018, lifting its policy rate by a quarter of a percentage point to 0.50%.

Ten-year U.S. Treasury yields Friday were up 15.1 basis points to 2.492%, after earlier rising above 2.50% for the first time since May 2019.

Bond markets in the U.S. and Canada are quickly readjusting its expectations after Fed Chair Jerome Powell said on Monday the central bank needed to move “expeditiously” to combat rising inflation, and he raised the possibility of a 50-basis-point rate hike in May.

Americans are going to see inflation of 6% or more in the foreseeable future, a pace that will not slow until the end of 2022 when food prices may fall, said Stephen Hoedt, managing director of equity and fixed income research at Key Private Bank.

“The Fed is going to be chasing its tail when it comes to this inflation situation. They’re behind the curve and even if they go 50 basis points in the next couple of meetings, they’re still behind the curve,” Hoedt said.

But rising prices for food and energy, items the consumer is keenly aware of, are unlikely to fall as much as policymakers would like and could keep inflation elevated, he said.

“The consumer is going to have its expectations set by what happens when they go to the gas pump or the grocery store. And that has the potential to embed a wage price spiral, and I think that’s really what we’re fearful of,” Hoedt said.

The odds that the Fed is able to conduct a soft landing based on history are fairly low, said Jimmy Chung, chief investment officer at Rockefeller Global Family Office.

“The Fed knows it’s behind the curve. It has to be aggressive in hiking rates and shrinking the balance sheet to fight inflation,” said Chung, adding the jobs market will remain strong this year but a recession is more likely in 2023.

“History will repeat itself. The collateral damage will be the economy.”

The spread between the U.S. two- and 10-year notes was 18.5 basis points, just above where the shorter-term yield is higher than the long end in what is called an inversion that often signals a recession.

In equity markets Friday, the S&P 500 ended higher on Friday as financial shares rose on the rise in bond yields.

The Nasdaq ended lower, and tech and other big growth names mostly declined, but they finished off session lows following a late-session rally.

For the week, the Nasdaq and S&P 500 registered solid gains of 2% and 1.8%, respectively, and the Dow was nominally higher with a 0.3% rise.

The S&P 500 financials sector gave the S&P 500 its biggest boost on Friday, rising 1.3%, while technology and consumer discretionary sectors were the only two major sectors to end lower on the day.

The equity market is pricing in a higher rate environment, said Keith Buchanan, portfolio manager at Globalt Investments in Atlanta.

That is causing bank stocks to outperform, while “adding more pressure to the riskier elements of the market,” such as growth shares, he said.

Higher borrowing rates benefit banks, while higher rates are a negative for tech and growth stocks, whose valuations rely more heavily on future cash flows.

The Dow Jones Industrial Average rose 153.3 points, or 0.44%, to 34,861.24, the S&P 500 gained 22.9 points, or 0.51%, to 4,543.06 and the Nasdaq Composite dropped 22.54 points, or 0.16%, to 14,169.30.

Shares of growth companies like Nvidia Corp eased after leading a Wall Street rebound earlier this week.

The utilities sector also rose sharply, hitting a record high as investors favored defensive stocks with the Russia-Ukraine war still raging after a month.

The sector ended up 1.5% on the day and up 3.5% for the week, while the energy sector ended up 2.3% on the day and jumped more than 7% for the week following sharp gains in oil prices.

Moscow signaled on Friday it was scaling back its ambitions in Ukraine to focus on territory claimed by Russian-backed separatists.

Economists at Citibank are expecting four 50 basis points interest rate hikes from the Fed this year, joining other Wall Street banks in forecasting an aggressive tightening path against the backdrop of soaring inflation.

Volume on U.S. exchanges was 11.92 billion shares, compared with the 14.28 billion average for the full session over the last 20 trading days. Advancing issues outnumbered declining ones on the NYSE by a 1.08-to-1 ratio; on Nasdaq, a 1.40-to-1 ratio favored decliners. The S&P 500 posted 57 new 52-week highs and five new lows; the Nasdaq Composite recorded 73 new highs and 79 new lows.

Canada’s main stock index added to this week’s advance, as higher oil prices boosted energy shares.

The Toronto Stock Exchange’s S&P/TSX composite index ended up 68.05 points, or 0.3%, at 22,005.94.

For the week, it was up 0.9%. That marks its fifth straight week of gains, its longest winning streak since December 2020.

Since the start of the year, the index has climbed 3.7%, which compares to declines for many global benchmarks, including the S&P 500.

“The TSX is more of a value story and value has been a winner compared to growth,” said Stan Wong, a portfolio manager at Scotia Wealth Management.

Value stocks tend to be less expensive than the broader market and feature prominently in the energy, materials and financial sectors that account for nearly 60% combined of the Toronto market’s weighting.

“I do like the long-term outlook for energy stocks. It is very positive given the structural demand and supply imbalances,” Wong said.

“I also like the financials and materials sectors. They look attractive over the intermediate term given the rising interest rate environment and given the fact the global economy continues to reopen.”

The energy group rose 2.8% as oil settled 1.4% higher at $113.90 a barrel.

Financials advanced 0.5%, while the healthcare group, which includes cannabis companies, rose sharply for a second day as a cannabis decriminalization bill heads for a vote in the U.S. House of Representatives next week. It ended 6.9% higher.

Technology was a drag for the TSX, losing 2.4%.

With files from Reuters

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