The low inflation sent Canadian bond prices skyward on Friday, but they couldn't hold on to the gains by session's end, although Canadian issues outperformed their US counterparts.
Expectations of rising rates typically hurt bond prices, since the increases make their fixed yields less attractive.
Earlier this week, market players were increasingly convinced the Bank of Canada would raise rates twice more at each of their remaining policy settings this year, but the inflation data had some players rethink their positions.
"The market is not fully pricing in two rate hikes from here to the end of the year, whereas previously it was very close to doing it. So you've got 1-1/2 rate hikes in terms of what's priced in now," said Levesque.
In contrast to the Bank of Canada, the US Federal Reserve has boosted its fed funds rate twice so far and is expected to raise it again next week.
The two-year bond rose 1 Canadian cent to C$99.96 to yield 3.021 percent, while the 10-year bond lost 4 Canadian cents to C$103.30 to yield 4.573 percent.
The yield spread between the two-year and 10-year bond moved to 155.2 basis points from 154.1 basis points at the previous close.
The 30-year bond, due 2029, shed 25 Canadian cents to C$109.15 to yield 5.094 percent. In the United States, the 30-year treasury yielded 4.909 percent.
The three-month when-issued T-bill yielded 2.40 percent, down from 2.41 percent at the previous close.
The Canadian dollar fell hard on Friday after Canada's inflation for August came in well shy of expectations and prompted a new debate on the pace of future Bank of Canada interest rate hikes.
The Canadian currency finished at C$1.2976 to the US dollar, or 77.07 US cents, down from C$1.2904, or 77.50 US cents, at Thursday's close.
The currency has been one of the more volatile currencies against the greenback this month, but has largely stayed in a C$1.2850 to C$1.3050 range.
"From a technical and positioning standpoint, the stage was set for a retracement in dollar/Canada, we just needed a catalyst," said George Davis, chief technical strategist at RBC Capital Markets. "The numbers today were right up that alley."
Canada's annualised rate of inflation cooled to 1.9 percent in August, missing forecasts of a fall to 2.1 percent, from 2.3 percent in July largely due to the easing cost of gasoline.
The Bank of Canada's measure of core inflation, which strips out volatile energy prices and some food, was 1.5 percent in August, short of expectations it would remain unchanged from July's 1.9 percent.
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