Quebec Leads Provinces to Biggest Monthly Gain Since 2008: Canada Credit

Canada’s provincial bonds, led by Quebec, posted the biggest monthly gain since December 2008 after some regional governments narrowed their budget deficits and federal debt yields plunged close to records.

Provincial bonds, with about C$454 billion ($429 billion) outstanding, returned 2.31 percent in August, including reinvested interest, according to Bank of America Merrill Lynch data. Debt sold by Quebec province handed investors 3.02 percent, while federal government securities returned 2 percent.

Investors are moving beyond federal bonds as yields approach record lows on concern the global economic recovery is faltering. Releases this month from the nation’s statistics agency showed weaker-than-expected data for producer prices, the current-account balance and retail sales.

“It was a great month for provincials,” Benoit Lalonde, vice president of fixed income at Laurentian Bank of Canada, said by phone from Montreal. “As rates chug down, all of a sudden that 40 or 50 basis points that you get extra on being long” provincial bonds has a bigger effect, he said.

Quebec debt led gains this month among 394 bonds in the Bank of America Merrill Lynch index. Four of the second most- populous province’s issues were among the top seven performers, with the 8 percent bonds due in December 2076 returning 6.1 percent.

Debt issued by Montreal, Quebec’s largest city, returned 3.45 percent in August, while notes of utility company Hydro- Quebec, which is based there, made 3.38 percent for investors, Bank of America Merrill Lynch index data show. These compare with a 2.71 percent return on Ontario’s bonds.

Ontario Bonds

Ontario’s 3.15 percent notes due in September 2015 yielded 2.47 percent today, about 43 basis points more than the Canadian 3 percent bond maturing in December 2015. The yield gap, or spread, averaged about 43 basis points in August, according to Bloomberg data.

The provincial bond rally may make it cheaper for provinces such as Ontario and Quebec to sell debt this year. Provinces have borrowed C$34.9 billion in the fiscal year that began April 1, or about 45 percent of requirements, with another C$42.3 billion left to issue, according to research by Warren Lovely at Canadian Imperial Bank of Commerce.

Elsewhere in credit markets, the extra yield investors demand to own Canadian corporate rather than federal debt remained at 145 basis points, the Bank of America Merrill Lynch data showed. Spreads this year widened to as much as 154 basis points in June after narrowing to 114 basis points in March. Yields on corporate debt rose to 3.63 percent.

Sovereign Issue

Canada will sell C$1.4 billion of 4 percent bonds due in June 2041 tomorrow. The previous auction of 30-year bonds on May 19 drew an average yield of 3.78 percent and a bid-to-cover ratio of 2.28 times, Bank of Canada data showed.

Statistics Canada reported today that the nation’s economy grew at a 2 percent rate in the second quarter, slower than the 2.5 percent expansion predicted by economists, according to the median of 18 forecasts gathered by Bloomberg News.

Saskatchewan, the Canadian prairie province that lies east of Alberta, reoffered its 4.75 percent bonds due in June 2040, bringing the total outstanding to C$1.05 billion. The bonds were priced to yield 82 basis points over government benchmarks.

Corporate bond returns beat provincials in the first three months of 2010 on concern that combined deficits would lead to elevated levels of borrowing, Nakamura said. His firm is “cautious” on the sector.

“Provincials probably had a bit to catch up, compared to investment-grade or high-yield” bonds, Tom Nakamura, a fixed- income portfolio manager for AGF Investments Inc., said by phone from Toronto. “They languished early in the year.”

Smaller Deficit

Ontario, Canada’s most-populous province, reported a C$19.3 billion deficit for the fiscal year ended March 31, less than Finance Minister Dwight Duncan projected in October. Nova Scotia last month reported a deficit of C$241.9 million for the same period, less than the C$488.4 million officials forecast in April.

Provinces benefited from “pretty good” economic growth in the first half of the year, Nakamura said. “We expect that to moderate significantly over the second half.”

Longer-term provincial bonds performed best, with debt due in 15 or more years returning 3.88 percent this month, compared with 0.63 percent for debt due in one to three years, the Merrill data showed. Longer-term debt yielded 97 basis points over federal government bonds yesterday, compared with as much this year as 109 basis points in May.

December 2010 bankers’ acceptances fell to as low as 1.03 percent last week, the lowest since the contract began trading in December 2007, as traders trim bets Bank of Canada policy makers, who meet Sept. 8, will increase interest rates for the third time since June 1.

“We’re not looking at a very aggressive Bank of Canada, we’re not looking at an FOMC that’s going to be hiking anytime soon,” said Nakamura, referring to the U.S. central bank’s rate-setting committee. His team oversees about C$6 billion, including provincial bonds. “In that environment, you’re seeing a lot of investors reach out for yield.”

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

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