The yield curve on Canadian government bonds inverted the most since early 2007 as investors flocked to bonds on concern that Donald Trump's surprise threat to impose tariffs on Mexican imports could derail the revised North American Free Trade Agreement.

Canada’s 10-year yields plunged to trade 17 basis points less than 3-month notes, according to data compiled by Bloomberg. The 10-year yield fell five basis points to 1.51 per cent, the lowest in two years. An inverted yield curve, in which short-term rates are higher than longer-term yields, is considered by some economists a signal that a recession is looming.

Investors are buying long-term bonds after President Trump announced Thursday evening a plan to impose a 5 per cent tariff on imports from Mexico to force the Latin American nation to bolster efforts to stop illegal immigration. The move came just hours after Vice President Mike Pence promised to approve the U.S.-Mexico-Canada Agreement this year, in a meeting in Ottawa with Prime Minister Justin Trudeau.

The “new threats of U.S. tariffs on Mexico - even as passage of the new USMCA seemed to be getting closer - is a reminder that no trade agreement or past indications of goodwill is really full protection against a re-emergence of tensions with the U.S. under the Trump administration,” said Nathan Janzen, an analyst at Royal Bank of Canada, in a research note. “That uncertainty will remain a headwind for business investment spending in particular.”

The increased trade tensions threaten a Canadian economy that is showing signs of emerging from its first-quarter slump. The economy grew by 0.5 per cent in March, topping estimates, after an expansion of just 0.4 per cent for the first three months of the year, Statistics Canada reported Friday.

“The current economic backdrop still looks okay, and better than quarterly GDP growth headlines in the last couple of quarters would imply,'' said Janzen. “There is still plenty of uncertainty about the outlook to keep the BoC on the sidelines in terms of any future interest rate hikes for now.”