For Canadian Bond Investors, Will 2026 Bring More Gains?

Key Takeaways

• Analysts have a benign outlook for the Canadian bond market in 2026, but with the potential for volatility around trade talks.
• Moderate growth and stable inflation mean bond yields are unlikely to stage large moves.
• The Bank of Canada is expected to hold interest rates steady for most of 2026, keeping short-term yields low and stable

Canadian bond investors can look forward to less volatility in 2026, thanks to a stable economic backdrop. However, potential fresh trade tensions with the United States could introduce new volatility.

The bond market just wrapped up a volatile year that saw government of Canada bonds—particularly short-term yields—respond sharply to US President Donald Trump’s trade war, economic uncertainty, and fears of a recession. The disruption led the Bank of Canada to cut interest rates by one percentage point over the year, fueling a drop in bond yields.

Overall, 2025 was positive for the Canadian bond market. The Morningstar Canada Government and Provincial Bond Index, made up of government of Canada bonds with maturities greater than one year, rose 1.9%. The Morningstar Canada Core Bond Index, which follows fixed-rate, investment-grade Canadian securities with maturities greater than one year, returned 2.3%.

Underlying those gains, Government of Canada two-year bond yields fell to 2.58% at the end of 2025 from 2.93% at the start of the year. By contrast, the yield on five-year bonds ended the year flat from where it started, at 2.96%, while 10-year bond yields rose to 3.42% from 3.22%. Yields across the government bond market have started 2026 drifting lower.

Looking ahead, the economic backdrop of growth and inflation suggests a relatively narrow band for bond yields. Despite a contraction in Canada’s GDP in October, recent strong jobs data suggests the economy is not headed for a recession. Further, inflation has remained contained over the past few months. Analysts see little reason for the Bank of Canada to raise or lower interest rates any time soon.

However, negotiations around the Canada-United States-Mexico Agreement could throw a wrench in that outlook and reintroduce volatility. Dustin Reid, chief fixed-income strategist at Mackenzie Investments, cautions that ”markets may still be underappreciating the potential for disruption along the way.”

Bank of Canada Rate Decisions and the Bond Market

As is almost always the case, the Bank of Canada’s decisions on interest rates will be critical to the outlook. For the near term, analysts expect Canadian monetary policy to be neutral to positive for the bond market.

Last year, the Bank of Canada cut interest rates four times, lowering its overnight rate to 2.25% from 3.25% at the start of the year. At their last meeting in December, policymakers determined the rates were at the “right place” and decided to enact a hold.

Further, recent signs of a labor market recovery and solid GDP data have revived some confidence in the economy, driving yields higher. This led the market sentiment to switch, fueling expectations for at least one quarter-point hike from the Bank of Canada in 2026.

Thomas Ryan, North America economist at Capital Economics, dismisses the likelihood of such a move: “Investors are somewhat premature in pricing in even the possibility of a rate hike [this] year.”

Mackenzie’s Reid goes a step further: “We are more cautious on the Canadian economic outlook, given slowing population growth and housing-related risks that have yet to fully play out. As a result, and assuming these pressures persist, we believe the Bank is more likely to cut rates at least twice [this] year, potentially before the end of the first half.” He adds that if that happens, it will affect yields across the curve, with short-dated bonds being the most sensitive.

Trade Talks Hang Over the Outlook

Once trade negotiations get underway later this year in July, analysts think the bond market could be vulnerable to whipsawing on the latest headlines. “While we expect an agreement to ultimately be reached, the path is unlikely to be smooth, and we believe markets may still be underappreciating the potential for disruption along the way,” says Mackenzie’s Reid.

A raw deal for Canada could disrupt its economic recovery and drive bond yields lower. Meanwhile, a renewal without significant changes could signal a win, causing an uptick in yields. “A favorable outcome for Canada, such as the removal of some US sector-specific tariffs in exchange for limited concessions, would likely push yields higher than our current forecasts show,” says Capital Economics’ Ryan.

Watching the US Fed

While the Bank of Canada is broadly expected to hold interest rates for much of 2026, it’s believed the US Federal Reserve will continue to cut rates, creating a policy gap between the two central banks.

“These diverging expectations could create volatility in the bond market,” says Sam Acton, portfolio manager and co-head of fixed income at Picton Investments. “Broadly, we continue to see the yield curve steepening as a dominant theme in fixed income for 2026, and we could see longer-dated yields drift higher.” A yield curve steepening occurs when the gap between short-term and long-term bond interest rates widens.

Mackenzie’s Reid sees an additional risk as Fed Chair Jerome Powell’s term ends. He says greater uncertainty might emerge if Powell’s successor follows a different policy path. “If markets begin to question whether policy is being eased below the so-called neutral rate, the risk is a perceived policy error,” he explains. “That could lead to a meaningful steepening of the yield curve, with 10-year and 30-year yields moving materially higher even if front-end yields move lower.”

The underlying assumption is that due to a strong correlation, any sharp moves in US Treasuries will eventually spill over the border. “Given the high beta between US and Canadian bonds, if there was a significant move lower in the front end of the US curve, the Canadian curve would likely also be affected, although perhaps not to the same degree,” says Reid.

Reid thinks the Bank of Canada’s policy path is likely to be the primary driver of short-term Canadian bonds. At the same time, US policy decisions will have a greater influence on longer-dated yields. “Together, these forces will shape both absolute yields and cross-border spreads,” he says.

Reid’s strongest conviction is at the front end of the Canadian curve, short-term bonds. “If our view [that the Bank of Canada cuts further and US Fed policy uncertainty takes hold] plays out, we see Canadian front-end yields moving 40-60 basis points lower over 2026, driven by our out-of-consensus expectations for Bank of Canada easing,” he says.

Further out on the curve, Reid expects more modest declines, “with intermediate and long-term yields potentially ending the year 25-45 basis points below current levels.”