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Investment Ideas Canada reclaiming haven status among global bond buyers

Canadian bonds had become a favourite of international investors during the global financial crisis and the nation’s sovereign debt has outperformed all its Group of Seven peers this year, according to Merrill Lynch index data.

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Canada's reputation as a refuge for bond investors during times of turmoil is being rekindled.

The nation's sovereign debt has outperformed all its Group of Seven peers this year, according to Merrill Lynch index data. In contrast, last year returns on Canadian bonds trailed behind every G7 nation except the U.S. and Japan.

What's fuelling the gains is a shift in sentiment on the outlook for an economy still adjusting to a collapse in the price of crude oil over the past year. At the same time, Canada's prudent fiscal practices have allowed it to maintain the highest credit rating among G7 nations, while avoiding most of the extraordinary stimulus measures embraced by the U.S., Japan and European Union members that have led to negative yields in countries such as Germany.

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"No. 1 for safety and No. 2 for a modest return, it's attractive," said Jonathan Lemco, senior sovereign debt analyst at Vanguard Group Inc. in Valley Forge, Pa. "Compare it [with] German bunds, which offer negative yields. To the extent we have discretion to overweight relative to other AAAs, we may overweight slightly."

Investors earned 1.8 per cent investing in Canadian bonds, more than U.S. Treasuries and the average 0.4 per cent in a basket of developed nations tracked by a Merrill Lynch index. This outperformance for Canada contrasts with last year, when foreigners sold $9.6-billion cdn of Canadian federal government bonds, the biggest net outflow since 2003, according to government data compiled by Bloomberg.

Canadian bonds had become a favourite of international investors during the global financial crisis. The country's banking system has been touted as the strongest by the World Economic Forum for seven straight years.

David Wolf, a portfolio manager at Fidelity Investments in Toronto, said last week that Canadian bonds still offer value because the Bank of Canada may cut interest rates to zero from 0.75 per cent in the next six to 18 months as a rising Canadian dollar threatens the recovery. Vanguard's Mr. Lemco said that with economic growth continuing to limp along in 2015, the Bank of Canada may revisit whether more stimulus is warranted later in the year.

Bank of Canada Governor Stephen Poloz left rates unchanged on May 27 and signalled he's prepared to wait out a recovery in exports after the collapse in the price of oil, even after Federal Reserve Chair Janet Yellen said she still expects to raise interest rates this year. Policy-makers led by Mr. Poloz said the "current degree of monetary policy stimulus remains appropriate" in their statement. The central bankers also flagged concern about a stronger currency that might set back the effect of the stimulus from a quarter-percentage point rate cut in January. That contrasts with Ms. Yellen on May 22, who said raising rates this year will be "appropriate," provided the economy meets her forecasts.

Canada became the first G7 member to ease monetary policy in response to the plunge in oil prices following a 50-per-cent drop in prices for crude, the country's biggest export.

"The slowdown in the Canadian economy on the back of the slide in oil and the surprise rate cut by Mr. Poloz all feeds into the Canadian bond market outperforming," said James Dutkiewicz, who oversees $19-billion as chief investment strategist at Sentry Investments Inc. in Toronto.

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Canada's economy unexpectedly shrank at a 0.6-per-cent annualized pace in the first quarter, a government report showed Friday. The drop – the first quarterly contraction in four years and the largest since the 2009 recession as the oil price plunge sapped business investment – exceeded all 22 economist forecasts in a Bloomberg News survey with a median estimate of a 0.3-per-cent expansion.

After the brunt of the oil shock in the first half, Mr. Poloz sees "positives" including stronger U.S. demand for Canadian goods to be highlighted in the second half. The bank forecasts economic growth this year will slow to 1.9 per cent from 2.5 per cent in 2014. Canada's benchmark 10-year government bond rallied, with yields falling five basis points, or 0.05 percentage points, to 1.62 per cent. Canada's 2.25-per-cent note maturing June 2025 added 50 cents to $105.81.

"This is not a credit you're going to get rich on," Mr. Lemco said. "But it continues to be one of the few AAA credits that offer modestly attractive relative value."

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