Some of the Bond Market's Biggest Lenders Are Avoiding Canadian Debt

  • Managers seek fatter yields elsewhere after first-half binge
  • `Day in sun is over' in aftermath of crisis: Pimco's Devlin

Just as Justin Trudeau looks like he’ll get the chance to implement his plan to prime Canada’s economy with debt, some of the world’s biggest investors say they’re not interested in picking up the tab.

Polls show Trudeau, leader of Canada’s Liberal Party, is going into Monday’s vote with enough support to unseat Conservative Prime Minister Stephen Harper after running a campaign whose centerpiece was to increase infrastructure spending with C$25 billion ($19 billion) in deficits over three years.

Justin Trudeau
Justin Trudeau
Photographer: Ben Nelms/Bloomberg

With government bond yields already near record lows after two central-bank interest rate cuts, some of the bond market’s biggest lenders say federal government debt doesn’t offer big enough payouts to be worth their while and are taking their money elsewhere.

"We’re not involved in the bond market," Alessio de Longis, a portfolio manager at the global multi-asset group of New York-based OppenheimerFunds, which manages $11.7 billion. "From a fixed-income perspective we find better yield opportunities in the U.S."

Trudeau has cited near record low borrowing costs as one reason the time is ripe for debt-funded stimulus. It’s unlikely he’ll secure enough seats to clinch a majority, the polls show, and a tight three-way race, including the New Democratic Party, could lead to a minority government with a combination of parties forming an alliance.

The highest foreign demand for Canadian federal debt since 2010 helped send the yield on the 10-year benchmark bond to a record low of 1.2 percent in August, and push the extra payments investors get buying the equivalent U.S. security to a record premium of 81 basis points.

Because the value of existing bonds increases as yields fall, holders of government debt have been rewarded by the falling rates with the second best performance in the Group of 10 developed nations this year, Bank of America Merrill Lynch data show.

But with the market growing more skeptical another interest rate cut is on its way as oil prices stabilize and growth picks up, yields look to have bottomed. Benchmark government yields will rise from current levels, around 1.5 percent, to 2.4 percent by the middle of 2017, according to the median forecast of economists surveyed by Bloomberg. That’s about the average of 2010 when Harper was running his biggest deficit. The average since 1996 is 3.7 percent, according to Bank of America data.

For much of 2010 through 2012, 10-year benchmark yields were higher in Canada than the U.S., data compiled by Bloomberg show.

Investors seeking to gain from central bank action inflating bond prices may start to look to the Bank of Japan or the European Central Bank instead, said Kurt Reiman, strategist at the investment institute of BlackRock Inc., the world’s biggest asset manager, with $4.5 trillion in funds.

"You have a better opportunity set in international-developed as well as international-emerging markets than you have domestically," he said. "The discussion in Europe is about whether the ECB extends its quantitative easing. The discussion in Japan is likewise about another round of balance sheet expansion."

When clients can, Reiman said he advises them to look for bonds outside of Canada entirely.

The last time Canada embarked on a deficit-funded stimulus program was in the midst of the 2009 recession under the Conservative incumbent Harper. Harper’s deficits dwarfed what Trudeau is proposing.

Then, Harper had the benefit of record international demand for Canadian debt as the country’s stable banking system and quick return to expansion after the recession made it a safe haven compared to other countries still locked in slow growth and crisis. Now, Canada’s economy has turned from leader to laggard after the high commodity prices which underpinned its economic resilience collapsed.

"Government bonds are unattractive," Ed Devlin, who manages the Canadian investments of Pacific Investment Management Co.’s $1.5 trillion in assets, and prefers buying inflation-protected, provincial and corporate debt instead. "The crisis was our day in the sun and now our day in the sun is over."

Canada’s top AAA credit rating, continued demand for Canadian dollar assets from foreign central banks seeking to diversify their reserves, and the relatively small size of Trudeau’s proposed deficits, mean he would likely have no trouble funding them at rates that won’t climb too much higher, said Jonathan Lemco, a senior sovereign analyst at Vanguard Group Inc., which runs the world’s biggest bond fund.

But as for what Lemco’s own funds would invest in, he says at these yields his firm is still lending to Canada’s provincial governments rather than its federal one.

"From our perspective, the federal government debt is not interesting," he said.

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