Like Canadian Homebuyers, Morneau Takes Bet on Short-Term Ratesby
Finance Minister says an `appropriate cost' at this stage
Government could miss out locking in low long-term rates
Like homebuyers gambling on floating-rate mortgages instead of locking in more expensive fixed rates, Canada is betting it can cut costs by borrowing short-term as it issues a record C$133 billion ($102 billion) in debt to fund an ambitious spending program.
“We’ve remained open to the consideration of issuing longer-term bonds,” Finance Minister Bill Morneau said in an interview Wednesday at Bloomberg’s headquarters in New York. “At this stage most of our issuance is really in the two, three, five, seven years, and that’s based on where we see the financing opportunities and the appropriate cost for us at this stage."
By focusing on short-dated maturities, Morneau is wagering that the historically low interest rates that have dominated the global economy will not drift too high. The finance minister and the Liberal government of Prime Minister Justin Trudeau delivered a budget on March 22 that featured big spending on social programs and infrastructure and about C$120 billion in cumulative deficits in the next six years.
So far, the bond market agrees with Morneau’s thinking. Canadian government bonds rallied across the curve in the days following the budget, making theme the second-best performing among their Group of Seven peers as markets scale back expectations for a rate rise from the U.S. Federal Reserve. The yield on the Canadian two-year government bonds dropped to 0.55 percent from an average of 0.98 percent over the past five years. Yields on Canada’s benchmark 30-year bond have fallen to 2.02 percent from an average of 2.62 percent over the past five years.
"The yield curve is so flat that they probably think they can roll it over a couple of times before they run into higher cost of debt-servicing," Raymond Humphrey, who manages $8.5 billion in Canadian assets for AllianceBernstein Holding LP, said by phone from New York. "You as a consumer, if you saw those rates, if you were able to finance yourself cheaply for a house for two years or pay triple or quadruple for 30 years, which would you choose?"
The bond market is currently pricing interest rates to be about the same in two years, Humphrey said. If they do rise, it will be as a result of better economic growth, which would still be a win for the government. Morneau is likely "not really worried about interest rates getting away from him," he said.
A focus on short-dated maturities is appropriate considering the government is planning C$4 billion in new infrastructure spending in 2016-2017, Stefane Marion, chief economist at National Bank Financial, said by phone from Montreal. Most of the 2016-2017 issuance will be used to refinance C$92 billion of old debt.
"With respect to infrastructure spending, people might say they should match duration --they should issue at the long end of the curve," he said. "I would argue that issuing at the short end of the curve right now makes sense given the size of the infrastructure program."
The federal government may also be focusing on two-, three-, and five-year bonds in order to avoid crowding out provincial issuers, who tend to issue at the long end, he said.
Canada followed an austerity course to return to balanced budgets under former Prime Minister Stephen Harper. The new government’s use of deficit-spending to help drive growth, and its refusal to commit to a time line for returning to balance, has raised concern the country’s debt to GDP ratio, may balloon. It currently stands at about 31 percent, the lowest in the G-7.
"We were here a dozen years ago it was hard work to re-balance," Humphrey said. "It’s always good when the government is making investments that improve GDP over the longer haul but the worry is that they’re spending money because they can, with little to show for it."
National Bank’s Marion thinks the emphasis on short maturities is a signal that Canada won’t be returning to structural deficits.
"By issuing at the shorter end of the curve, to me it’s a message that we don’t plan to run structural deficits," he said.