Canada Missed Ultra-Long Opportunity Before Trump Yield SpikeBy
Morneau told of risks after department published auction rules
Bloomberg obtained memo under freedom of information law
Officials discouraged Canada’s finance minister from selling further ultra-long maturity debt, and potentially locking in near-record low borrowing costs for a generation, just ahead of a surge in yields spurred by the election of U.S. President Donald Trump.
Bill Morneau was told interest-rate forecasts had been “consistently too high” and a weak global economy suggested low rates could persist, according to an Oct. 25 briefing obtained by Bloomberg through a request for records under the Access to Information Act. The report also suggested savings from the first C$3.5 billion ($2.6 billion) of 50-year government bonds sold in 2014 had been disappointing, though some of those findings were redacted.
The briefing shows officials were cautious about the long-term debt program, even as the wheels were in motion to issue more. An Oct. 11 announcement from the Bank of Canada, which manages the government’s debt sales, laid out rules for a potential new ultra-long auction, and an earlier annual debt strategy said another one could happen if market conditions were right. Since then the prospects for a sale have worsened considerably.
“There is some demand for these bonds, but not with the same eagerness as if interest rates were falling and it seemed like they would continue to fall,” said Aubrey Basdeo, head of Canadian fixed income at BlackRock Inc.
Officials suggested the case for issuing long- or ultra-long debt was less compelling in a world where low interest rates could persist. Lower yields across different maturities since the first sales of 50-year debt made the government’s total borrowing program cheaper, the memo said. Longer-term bonds are typically more expensive to sell to investors than shorter-dated securities due to greater interest rate risk and potential for default.
The yield on the government’s 2.75 percent bond due 2064 has surged 85 basis points to 2.5 percent since the start of October and 30-year bonds about the same amount, part of a trans-border shift as expectations for faster growth and inflation in the U.S. prompt investors to abandon the relative safety of bonds in favor of higher risk assets.
“It’s more of a flesh wound as opposed to a serious injury, not having made that call then” on ultra-longs, said Terry Carr, head of Canadian fixed income at Manulife Asset Management Ltd. in Toronto. “They also want to build up liquidity in the ultra-long end and they will probably perceive some opportunity in the next year or so.”
Finance department officials in a note sent by deputy minister Paul Rochon also said major new long-term debt sales could distort other parts of the bond market. Long-term debt stood at 43 percent of the outstanding stock, and a big increase “would reduce the liquidity and well functioning of short- and medium-term sectors.”
Mark Chandler, head of fixed-income strategy at Royal Bank of Canada’s RBC Capital Markets unit in Toronto, said he hasn’t seen that become a big problem. “Markets have been pretty liquid,” as the government boosted sales of shorter-term securities, he said. Canada’s debt management plan for the fiscal year ending March 31 called for the majority of new sales in two- and five-year debt, and an ultra-long sale if conditions favored it.
There is also a natural demand for ultra-long maturity debt from buyers who need to match against liabilities due decades from now. “It’s a specialty niche in the marketplace,” said Chris Kresic, a portfolio manager in Toronto at Jarislowsky Fraser Ltd. He helps oversee a total of C$38 billion in assets. “There are obviously pension plans and insurance companies that will look to hedge liabilities.”
“The Government continues to monitor the evolving market conditions and remain open to the possibility of issuing” ultra-long maturity bonds, finance department spokesman Jack Aubry wrote in e-mailed comments about the program. The October ultra-long auction rules announcement “didn’t constitute a commitment to issue, which remains a tactical decision.”
Historically low yields on global bonds worldwide have led Canada and other governments, including South Korea and Italy, to sell 50-year debt, betting they will save money over time when borrowing costs rise.
Finance officials signaled to Morneau that the 2014 sale of 50-year bonds didn’t live up to expectations. The sale was “originally expected to result in savings for the government based on interest rate forecasts at the time,” the department’s updated October report on debt strategy said. The next paragraph was blanked out, beginning again stating that “the lower rate environment that materialized since 2014 has resulted in significantly lower debt charges for the overall debt program.”
The latest monthly budget figures showed the costs of carrying Canada’s debt shrank to C$18.5 billion between April and December of last year, from C$19.8 billion in the same period in 2016.
Canada’s borrowing costs are also being held down by its status as one of just 10 countries with triple-A grades from the three leading debt rating companies. Morneau told reporters last week the budget he’s presenting March 22 will maintain fiscal responsibility.
The budget’s new annual debt strategy will probably retain the option to sell ultra-long bonds again if conditions are right, said Chandler at RBC Capital Markets, adding “They will be opportunistic.” Yields on the debt are still at least 10 basis points below what the government paid to borrow in the cheapest of its three 2014 sales of ultra-long dated securities, he and Simon Deeley wrote in a March 8 research note.