A stable economy and strong debt rating is drumming up sky-high demand for Canadian bonds, as investors seek safety from global volatility.
For the second year in a row, Canadian bond returns outperformed the global benchmark – a trend forecasters believe will continue in 2012 as developed countries grapple with crippling debt and emerging economies face the threat of a sudden slowdown.
Since January, Canadian government and corporate bonds have returned 9.6 per cent, almost doubling the global average of 5.5 per cent. Much like last year, the thirst for these bonds, from both domestic and foreign buyers, stems from a relatively healthy Canadian economy.
Gross domestic product is growing, slowly but surely, and Canada has proven to be a relative haven with its triple-A federal debt rating. Contrarily, Standard & Poor’s threw markets into a tailspin in August by downgrading the United States’ debt.
On Wednesday, during a typically quiet trading period, investor concern about the U.S. and European economies in the early part of 2012 pushed U.S. stocks down over 1 per cent and sent the euro to a 10-year low against the yen. This year, those same worries drove central banks around the world to diversify their holdings beyond the greenback and the euro, weakening those currencies and creating strong support for the loonie.
The more Canadian dollars that central banks pick up as a result of worries elsewhere, the more will be reinvested in Canadian bonds.
“The hype around Canada is still intact,” said Jean-François Godin, senior fixed-income market analyst at Desjardins Securities. “Maybe not as high as before, because it’s becoming old news, but the fiscal situation remains very favourable.”
Canada ranked behind only Germany in a new economic report card from Bank of Montreal, which compared inflation, jobless rates, budget deficits and credit ratings among the world’s biggest industrialized economies. But Canada’s picture isn’t entirely rosy, according to the bank. BMO warned that demand for the country’s bonds could evaporate if fiscal prudence isn’t maintained, and that the country’s second-place ranking speaks more to its peers’ poor performance than anything.
Canada’s holes begin to appear when compared with Germany, the top-ranked country. Germany’s debt load is much more manageable, and the country exports more than it imports. “The major weak spot for Canada – and this is a relatively new development – is our 3 per cent of GDP current account deficit, compared with a surplus for Germany,” BMO economists Doug Porter and Benjamin Reitzes wrote.
“As well, on the budget deficit front, Germany made big strides to rein in its shortfall, while Canada’s deficit remains relatively large at 5 per cent of GDP (in part due to a still-wide gap at the provincial level).”
After Canada’s bond market beat the Global Broad Market Index in 2010, fixed-income analysts weren’t sure demand would die down. “We thought it was going to wane,” Mr. Godin said. “But it didn’t.
This strength is largely owed to provincial bonds, which domestic buyers and foreigners continue to scoop up.
A jaw-dropping $57-billion of provincial debt was raised from April, 2010, the start of the provinces’ fiscal year, to December, and 2011 churned out the exact same figure as provinces continue to borrow to fund their deficits. Demand for these bonds has been so strong that in several instances, buyers have approached the provinces directly and promised to purchase a certain amount, typically $200- to $500-million of a new public offering, giving the provinces confidence to come to market.
Still, much like the feds, provinces have reason to be cautious. Earlier in December, ratings agency Moody’s Investors Service lowered Ontario’s outlook from ‘stable’ to ‘negative,’ following similar moves by S&P and DBRS Ltd.
Plus, the Canadian story may eventually grow old as investors find solace in another developed country.
“The danger obviously is that some investors reallocate their cash eventually,” Mr. Godin said. “We’re not saying that yet … but some people may start thinking about it.”
With files from Bloomberg News