How Surging International Investment is Suppressing Canadian Yields
Foreign investors including pension funds, insurance companies and hedge funds are buying Canada’s federal bonds in record amounts, easing the cost of funding Prime Minister Mark Carney’s expensive nation-building projects but potentially introducing more volatility to Canada’s debt market.
The most recent data for Government of Canada bonds shows that foreign investors purchased $27.7-billion in April, a record monthly total, while their share of the bonds outstanding climbed to an all-time high of 43 per cent. Among Group of Seven sovereign debt markets, only France and Germany, backed by the euro’s status as a major reserve currency, attract a higher foreign stake.
Carney has committed to investing over $280-billion in the next five years on infrastructure, defence and housing as well as on measures to enhance productivity, much of which is expected to be financed in the bond market. A wider investor base could increase the chances of keeping borrowing costs in check.
“I regard the broader buyer base as a positive development, which has helped the Canadian government fund relatively large bond programs without unduly raising borrowing costs,” said Andrew Kelvin, head of Canadian and global rates strategy at TD Securities. The move into Canadian bonds, despite lacklustre economic growth, reflects confidence in Canada as part of a shrinking band of countries whose bonds receive a triple-A credit rating. Among the big-three agencies, Moody’s and S&P Global give Canada the top rank, while Fitch rates Canada’s bonds AA+.
The Bank of Canada adding global investment banking powerhouse Goldman Sachs to the list of Canadian government securities distributors could also increase participation by foreign investors, including hedge funds. Hedge funds buy almost 50 per cent of GoC bonds at auction in some maturities and represent about 30 per cent of the volume of trades between dealers and clients in the secondary market, according to the BoC. The central bank has worried that a sudden unwinding of the leverage that hedge funds employ could be a risk to financial stability.
Another potential risk is an abrupt exit from the market by foreign buyers, a dynamic that France endured during a period of political uncertainty in 2017. Investors are also diversifying away from U.S. Treasuries, according to a report last month by the Institute of International Finance that suggests that U.S. government debt increasingly looks to be on an unsustainable path.
“Diversification away from Treasuries is one likely driver of increased foreign bond holdings in Canada, not least because of the high sovereign bond rating of Canada and liquid markets,” said Robin Marshall, director, global investment research at FTSE Russell. The size of the GoC bond market has more than doubled since the start of the decade to nearly $1.3-trillion, after Canada ran persistent budget deficits. Among G7 countries, Canada is in the middle of the pack when measuring gross indebtedness once provincial borrowing is included.
But Canada’s net debt, which takes account of financial assets such as the Canada Pension Plan and the Quebec Pension Plan, is the lowest in the group by far, at 10 per cent, and its cost of borrowing, at about 3.40 per cent over a 10-year term, is about one percentage point less than the rate investors demand on U.S. debt – a wide gap by historical standards.
“Strong foreign appetite for Canadian government debt represents a vote of confidence in the stability of the country’s political institutions and its overall economic trajectory,” said Karl Schamotta, chief market strategist at Corpay.
This article was first reported by Reuters
