Foreign Debt Demand May Ease, Royal Bank, Scotia Bank Say: Canada Credit

The record pace of foreign purchases of Canadian government bonds so far this year may cool as the central bank moves ahead with interest-rate increases, according to Royal Bank of Canada and Bank of Nova Scotia.

Foreigners bought a record net C$23.2 billion ($22 billion) of Canadian securities in May, led by C$11.5 billion of federal government bonds, the most ever and almost double the previous record of C$6.75 billion in January, Statistics Canada said yesterday in Ottawa.

Interest rates in Canada, which ships about three-quarters of its exports to the U.S., will be 150 basis points higher than in its southern neighbor in the first quarter of 2011, Royal Bank of Canada estimates. The Bank of Canada today raised its target rate by a quarter point to 0.75 percent, the second increase in less than two months, in a move predicted by all 20 analysts surveyed by Bloomberg News.

Purchases of government bonds by “opportunistic” investors may be unwound as market pricing and opportunities become more attractive in other countries, Mark Chandler, head of Canadian fixed-income and currency strategy at Royal Bank of Canada in Toronto, the nation’s largest lender, said in an e- mail.

Australia’s bonds may offer better value than Canada’s because its central bank is “closer to neutral” on interest rates, and the country’s fiscal position is “even brighter” than Canada’s, Chandler said.

Foreign Purchases

“The January to May pace would be hard to maintain,” said Chandler. Waning foreign interest in Canada’s bonds would help push bond yield higher, he said.

Foreigners purchased a net C$44.3 billion in bonds in the first five months of 2010, compared with C$37.2 billion in the same period last year and C$24.3 billion in January through May 2008, according to Bloomberg data. Inflows were less than C$10 billion in each of 2007, 2006 and 2005, the data show.

Elsewhere in credit markets, the extra yield investors demand to own the debt of Canada’s corporations rather than its federal government, widened yesterday to 144 basis points, or 1.44 percentage points, from 143 on July 16, according to a Bank of America Merrill Lynch index. Overall yields fell to 3.938 percent.

Wholesale sales rose 0.4 percent in May after falling unexpectedly in April, Statistics Canada is likely to say tomorrow, according to the median of 15 forecasts in a Bloomberg News survey.

Bank of Canada Governor Mark Carney on June 1 became the first Group of Seven central banker since July 2008 to lift borrowing costs, increasing the benchmark rate to 0.5 percent.

‘Hike and Go Neutral’

“The wheels have generally fallen off the Canadian- overweight theme so far this month,” , Derek Holt, a Toronto- based economist at Bank of Nova Scotia’s Scotia Capital unit, said in an e-mail.

“I think that continues through the summer on global growth worries, barring a suddenly more hawkish Bank of Canada compared to the hike-and-go-neutral bias they have adopted,” Holt said. Foreign investors who overweight Canadian bonds for “more than the near term will be rewarded,” he said.

Economists had predicted a C$6.5 billion net purchase of Canadian securities in May, according to the median of three estimates in a Bloomberg survey.

Stewart Hall, an economist at HSBC Holdings Plc’s HSBC Securities in Toronto, said international purchases of Canadian bonds could continue apace “on the basis that sovereign event risk is likely to be with us for some time.”

‘Issues of Liquidity’

“Canada is a fire-and-forget destination for capital,” Hall said in an e-mail. “That said, as with many relatively small markets there are issues of liquidity.”

Canada’s bond market “lacks the depth of liquidity offered by the U.S. Treasury, that indeed makes it the world’s only real safe haven,” Hall said.

The yield on Canada’s 10-year bond will rise to 3.57 percent by the middle of next year, according to the average forecast of three economists in a Bloomberg survey. It closed yesterday at 3.16 percent, as the 3.5 percent security maturing in June 2020 fell 3 cents to C$102.82.

To contact the reporters on this story: Chris Fournier in Montreal at cfournier3@bloomberg.net

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