Canadian job growth surges, bond investors adjust interest rate bets

In January, the Canadian economy added a surprising 150,000 new jobs, which is ten times more than what experts had predicted. In the US, the employment figures were also positive, adding 517,000 new jobs, well above the consensus estimate of 185,000.

This has led bond-market investors to adjust their bets on the Bank of Canada's policy-rate path for the year. Before this news, investors had anticipated two quarter-percentage point cuts; now, they predict that the Bank's policy rate will either stay the same or potentially rise by an additional quarter point.

However, despite the positive employment data, inflation may take longer to return to target than expected. Wages have grown at about 5% on a year-over-year basis for eight consecutive months, making it difficult to imagine how inflation can fall back to its 2% target.

BoC Governor Tiff Macklem has acknowledged that "the labor market is very tight" and stated that "if the labor market stays this tight, we're not going to get back to 2-per-cent inflation."

Market watchers believe that the Canadian and US economies can achieve a soft-landing, where a return to target inflation is achieved without requiring a recession.

However, as a growing proportion of current inflation pressure is coming from domestic sources such as services, which are heavily impacted by labor costs, there is no guarantee that the same dynamic will hold going forward.

For these reasons, choosing a variable rate today should be seen as an aggressive bet. Variable-rate borrowers starting a new term today must initially pay an interest-rate premium of about 1% above the available fixed-rate equivalents.

Opting for a fixed rate is currently the safer middle-of-the-road choice, and today's three-year fixed rates offer the best combination of near-term protection and competitive pricing.

Three years should be enough time for central bankers to wrestle inflation down to target, and three-year fixed rates don't carry the significant premium that one- or two-year fixed-rate terms have.