Provincial Bonds Decline Most in Two Years on Rate Outlook: Canada Credit
Canada’s provincial bonds posted their worst monthly decline in more than two years as borrowing costs rise amid an accelerating global economy.
The Bank of America Merrill Lynch Canadian Provincial Index dropped 2.1 percent this month, including reinvested interest, the most since September 2008. Losses on provincials bonds such as Quebec and Newfoundland were larger than those of Canadian government bonds, at 1.8 percent, and corporates, at 1.3 percent.
Bond prices worldwide are falling, tracking Treasuries lower after the Federal Reserve kicked off a second round of unconventional stimulus known as quantitative easing on Nov. 3, and as economic data in North America and globally point to a gathering recovery.
“It’s a generalized sell off in the bond market that’s tarred the provincial bonds with that brush,” Eric Lascelles, chief economics and rates strategist at Toronto-Dominion Bank’s TD Securities unit, said in a phone interview. “Global growth has improved. U.S. data is looking generally a lot better.”
Although November returns have dropped, provincial spreads over benchmarks are unchanged, indicating the weakness is not related to lack of demand for the asset class, Lascelles said.
The relative underperformance of provincial bonds is “give back for some pretty impressive gains” this year, he said. Through the end of October, provincials had risen by 8.4 percent, compared with 7.9 percent for corporates and 7.3 percent for governments, according to the Merrill data.
The longer duration of provincial bonds is contributing to their underperformance this month, according to Marc Rouleau, a fund manager at Standard Life Investments in Montreal. Merrill’s provincial bond index averages 7.3 years of duration, versus governments at 6.2 and corporates at 5.6.
“Higher rates are a significant source of the weakness,” said Rouleau, who helps manage about C$20 billion ($19.8 billion) in bonds. “Higher rates hurt longer-duration assets.”
Elsewhere in credit markets, the extra yield investors demand to own the debt of Canadian corporate rather than federal government debt widened yesterday to 136 basis points, from 135 the day before. Spreads were as high as 143 basis points this month and as tight as 134. Yields ended at 3.91 percent, from 3.92 the day before.
Tim Hortons Inc., Canada’s largest fast-food chain, sold C$100 million in a reoffering of its 4.2 percent senior unsecured bonds due in June 2017, bringing the total outstanding to C$300 million, the Oakville, Ontario, company said in a statement yesterday. The proceeds will be used to refinance debt maturing in February. The debt priced to yield 104 basis points over government benchmarks.
Global corporate bond spreads ended yesterday at 170 basis points, as yields rose to 3.71 percent.
Relative yields on provincial bonds widened to 53 basis points yesterday from 52 basis points the day before, the Merrill data show. They were 53 basis points at the end of October. Spreads have been as low as 51 basis points in November and as high as 54. Yields fell to 3.28 percent yesterday.
Merrill’s provincial index has only lost more than 2 percent in a month four times since 1995, with the loss in November the third largest. It lost 2.2 percent in March 2002 and 2.1 percent in August 1998.
Saskatchewan Finance Minister Ken Krawetz said in a statement yesterday the province expects to finish the fiscal year with a surplus of C$137 million, as oil and potash sales increase. Krawetz reduced the province’s expected borrowing program by C$186 million.
Canada’s third-quarter current account deficit likely widened to C$15.2 billion from C$11 billion in the prior three months, according to the median of nine estimates of economists surveyed by Bloomberg. Statistics Canada will release the data on Nov. 29 in Ottawa.
The agency reported on Nov. 23 that annual inflation accelerated to 2.4 percent in October, more than all 22 economists in a Bloomberg survey had predicted, and retail sales rose for a fourth straight month.
The gap in the Canadian two-year yield over the equivalent- maturity U.S. security touched 120 basis points on Nov. 23, the most since January 2004. Two-year Treasuries yielded 0.52 percent. U.S. markets were closed for Thanksgiving.
Spreads in 10-year Ontario bonds over underlying federal benchmarks narrowed about 0.5 basis point, while yields rose 27 basis points, according to Canadian Imperial Bank of Commerce data as of Nov. 22. Five-year Ontario spreads narrowed 1 basis point, as yields climbed 34.5 basis points.
“Higher yields and lower prices on provincial bonds are entirely due to a selloff in Canadas, which took their direction from a back-up in U.S. Treasury yields,” Warren Lovely, governments strategist at CIBC World Markets in Toronto, wrote via e-mail. “Demand for provincial bonds remains strong.”
Bonds of Newfoundland, Prince Edward Island and Quebec have suffered the most in November, with losses of 2.9 percent, 2.9 percent and 2.8 percent, Merrill data through yesterday show. Ontario, New Brunswick and British Columbia, with declines of 2.4 percent, 2.5 percent and 2.5 percent, fared best.
Merrill’s provincial index, with 397 bonds an C$463 billion outstanding, contains bonds from issuers such as Canada Housing Trust, Financement Quebec, University of British Columbia and York Municipality, as well as Canada’s 10 provinces.
The yield on 10-year Treasuries has increased about 30 basis points since Nov. 3, the day the Fed unveiled its plan to buy $600 billion in bonds to spur the economy in a second round of quantitative easing.
Bond prices could rally into the end of the month, because government bonds mature and pay coupons on Dec. 1, according to TD’s Lascelles, who estimates more than C$15 billion will be flowing into the hands of Canadian bond investors. He said bond markets “often” rally into Dec. 1, though this year has been different because of quantitative easing.
“There’s a reason to think there could be a lot of buyers going into the end of the month,” Lascelles said. “All else being equal, that translates into a rally, but of course all else isn’t equal, and that’s where the complications arise.”
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