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Derivatives

Canadian govvies set to perform despite tough times ahead

After five years as the safe haven’s safe haven, the Canadian government bond market is facing up to lacklustre domestic growth, low rates and an increasing dependence on the US to boost the economy. But, as Ralph Sinclair discovers, now might not be the time to dump your Canadian govvie holdings.

At first glance, Canada’s might not be the sought-after government bond market it has been throughout much of the crisis era. The Canadian dollar has rocketed in value and rates in the country are low and set to remain that way. Meanwhile, the domestic sector of the economy that dragged the country so ably through the crisis, appears to be running out of steam and the export sector, which will depend in great part on US and emerging market growth for its own wellbeing, is expected to take up the slack. 

But this year the Canadian Department of Finance expects the average rate the country pays on its debt to fall below 2.5% despite the fact it also expects the average term to maturity of Canadian government debt to have increased by the end of its fiscal year in April 2014. Those are hardly the characteristics of a market on the skids.

Although economic growth may be tapering, Canada still compares well to its advanced economy peers. That economic performance has driven central bank demand for Canadian dollar assets, particularly government bonds. The fact that it is central banks’ money suggests that it is likely to stick with the currency for some time. Bank treasury demand has also risen for government debt given the Canadian banking sector’s sprint to Basel III and core assets.

But the real driver is on the supply side of the equation. Canada is committed to returning to a balance by 2015 and, as prime minister Stephen Harper said in Russia at the G20 summit in early September, a debt-to-GDP ratio of 25% by 2021.

The effect of that strategy on government bond supply has been for a fall in the size of the programme by C$7bn to C$87bn for fiscal year 2013-2014 from the year before. 

The change to net supply is even more telling. From a peak in 2009 of net issuance of C$70bn, the net supply of Canadian government bonds has shrunk to around C$10bn, according to CIBC.

Short dated debt volume is also set to fall. Canada’s treasury bill stock stands at around C$200bn at the time of writing. But it is about to plummet to C$150bn by fiscal year-end in April as Canada absorbs cash from around C$40bn of mortgage assets rolling off of its books that it bought from banks in 2009 under the Insured Mortgage Purchase Programme. Another C$10bn of IMPP assets are set to mature the following fiscal year.

That will extend the country’s average debt maturity profile. But Canada is also looking at other ways to achieve the same thing. It has increased, through auctions, its sale of bonds in the 10-30 year part of the curve.

The Department of Finance, which is responsible for the debt management strategy, in conjunction with its fiscal agent, the Bank of Canada, has also been investigating an ultra-long dated deal. The trade could come this fiscal year and would most likely be sold by syndication.

Away from the Canadian dollar, investors may have new means to buy Canadian sovereign credit. The country is an infrequent visitor to international markets and as such is in hot demand when it brings a new bond issue. Its last two trades were a dollar five year, sold in February 2012 and a euro deal in 2010.

The country only borrows in foreign currencies to manage its foreign reserves, which it aims to keep at least 3% of GDP, and to meet IMF commitments. It achieves most of this target using cross-currency swaps. It issues global bonds when a cost saving versus domestic funding can be achieved. But it is exploring now the addition of medium term note funding to its programme.

Such a programme would mean that investors desperate for Canadian sovereign paper could originate a bond through reverse enquiry rather than waiting around for a global deal in which it may suffer in the allocation process. 

The programme would allow the borrower cheaper funding costs and to be able to borrow closer to the exact sizes it needs to match its foreign funding needs.  

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