While it’s clear that interest rates are heading upward, a new report from CIBC World Markets finds that the hikes will be lower than in previous cycles and fall below what many, including the U.S. Federal Reserve, are predicting.

“The nature of the upcoming expansion will dictate that, even at full employment, U.S. rates will have to be lower than in past cycles, in both real and nominal terms,” says CIBC Chief Economist Avery Shenfeld. “Similarly, Canadian overnight rates could end up reaching a plateau at surprisingly low levels.”

The report, co-authored by Shenfeld and CIBC Senior Economist Peter Buchanan, shows that in both countries, the neutral rate — the level at which interest rates neither stimulate nor restrain economic growth — could be only 2.5 per cent, well below the 4 per cent the Fed forecast at its latest meeting.

Shenfeld says that both Canada and the United States are headed for substantially slower growth in the working-age population, decelerating to less than half the pace seen in the last expansion. Unless productivity soars, he says the pace of potential (non-inflationary) real GDP growth will also decelerate. In addition, lacklustre capital spending and increased savings rates — particularly in emerging market economies — puts a further damper on the prospects for economic gains.

While this is good news for the bond market, the co-authors are not making a bullish call just yet, since even if overnight rates in both the U.S. and Canada pause at 2.5 per cent for an extended period of time, the bond market in 2014-15 might not anticipate a long pause and overshoot in their sell-off.

“To bond players, rate hikes are like potato chips; once you eat the first one, you go through the whole bag,” says Shenfeld.

He expects bond rates to climb sharply next year, but reverse course in 2016 as central banks take an early breather on rate hikes. He expects 10-year U.S. Treasury yields to top out in the 3.5-4 per cent range in this cycle, about 100-150 basis points below the last decade’s peak. In Canada, he says yields should be lower given the country’s higher credit rating and lower government debt.

“While expecting higher yields through 2015, we see the Bank of Canada surprising markets with a pause on rates in 2016 and the Fed doing so after one more hike, helping bond yields recoup some lost ground,” he says.

As well, he believes a more gentle climb in rates “will be a plus for equity multiples”.