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A Canadian flag flies on Parliament Hill in Ottawa. (Sean Kilpatrick/THE CANADIAN PRESS)
A Canadian flag flies on Parliament Hill in Ottawa. (Sean Kilpatrick/THE CANADIAN PRESS)

Credit Markets

Foreign investors seek haven in Canada Add to ...

The debt crises gripping Europe and the United States have prompted the world's biggest investors to broaden their search for havens in global bonds - and Canada is rising to the top of their list.

Amid festering uncertainty in Europe and the United States, Canada is among a small list of sovereign debt issuers to benefit, as central banks, pension funds and other big money managers diversify their holdings away from some of the traditional foundations of global money markets - the U.S., the euro zone and Japan.

"It's safe yield in a world where sovereign debt is being called into question. But it's also attractive yield," said Tom O'Gorman, director of fixed income at Calgary-based fund company Bissett Investment Management.

That combination is fuelling a pro-Canada trend in the bond market, as foreign investors are drawn to the country's stable financial system and superior economic potential. For Canadians, the influx of foreign capital is contributing to lower borrowing costs for governments and lower long-term interest rates - but also to an elevated Canadian dollar.

In their hunger to tap into Canada, the world's central banks are even turning their attention to provincial bonds - a segment of the market most have largely ignored in the past.

"People who buy bonds around the world are snapping up our bonds," Ontario Finance Minister Dwight Duncan told The Globe and Mail's editorial board at a meeting Wednesday. "They see our bonds as safer than a lot of nationals. In the old days a lot of central banks wouldn't buy subnationals, but now they're doing that."

Statistics Canada reported this week that foreign buyers made net purchases of more than $11-billion of Canadian bonds in May -the biggest number in a year.

A flood of buying has driven the yield on Canada's benchmark 10-year government bond down 20 basis points this month, even though forecasters expect the Bank of Canada to raise interest rates well before most other developed nations, something that would typically push bond rates higher and depress their prices.

"If you take a look globally, [in Canada]you have commodity-driven exports, you've got one of the safest banking systems in the world … Canada is a fairly well-rounded country as far as what it can offer for protection," said Michael Leavitt, institutional derivatives broker at MF Global in Montreal.

Over the past three months several other countries - including the United States, Germany, Britain and smaller issuers such as Switzerland, Australia and Sweden - have seen even bigger rises in their bond prices (and corresponding drops in their bond yields) than Canada.

But Jim Gilliland, head of fixed income at Leith Wheeler Investment Counsel Ltd. in Vancouver, said the Canadian bond trend is different. While the rally in Canadian bonds reflect a flight to quality, the rally in most of the more stable European debt issuers has more to do with declining expectations for central bank rate increases, reflecting the fading outlook for European economic growth.

The difference can be seen in yield curves - the range of a country's bond yields across its different bond issues, from the very short- to very long-term.

"In a pure flight to quality, people are buying 10-years [and]long assets - you tend to see more of a [yield]curve flattening," Mr. Gilliland said. This hasn't been the pattern in Germany and other core European bond markets, but it has started to take shape in Canada. Long-term yields have recently been falling faster than short-term yields, as the short end of the curve comes under pressure from rising expectations that the Bank of Canada will raise its benchmark rate.

"Foreign-investor interest and even pension-plan interest is creating a bid for longer-term securities," he said.

Reflecting the foreign interest, about 10 countries' central banks have bought Ontario bonds in the "relatively recent past," Ontario Finance Ministry spokesman Darcy McNeill said. While a few central banks bought Ontario bonds previously, it was rare. Now, "you could indeed call it a trend."

A B.C. Finance spokesman said central banks from Europe and Asia bought 38 per cent of a $1.5-billion (U.S.) bond issue in June. A Quebec government spokesperson also confirmed recent central bank buying.

Bond market participants said Canada should remain a highly attractive option for big foreign buyers as long as debt questions continue to hang over the U.S. and European markets. However, the relatively small size of the Canadian bond market will keep a lid on the buying - there simply aren't enough Canadian bonds to allow the biggest buyers, such as major central banks, to use Canada to diversify their massive portfolios in a meaningful way.

"The size will be an issue to some players who are very large," said Bissett's Mr. O'Gorman. "I think some [fund]flows will go to Canada, and some will flow to other smaller markets."

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