Economist sees vulnerabilities from abundant Canadian bond supply

Economist sees vulnerabilities from abundant Canadian bond supply

Economist sees vulnerabilities from abundant Canadian bond supply Noting an increase in federal bond issuances from the Bank of Canada compared to last year, a senior economist from the Desjardin Group suggests that this may leave Canadian debt securities vulnerable in the future.

In a July 20 statement, Desjardin Senior Economist Jimmy Jean notes a sizeable increase in federal debt issuances compared to last year. A total bond issuance of $132 billion has also been planned for the fiscal year, with the government aiming to increase issuance of two- and five-year bonds. The previously discontinued three-year bond has been reintroduced, with the first auction taking place on July 13. All this implies an increased significance of Canadian bonds with maturities of up to five years, including the summer season which typically sees decreased market liquidity.

All other factors being equal, increases in supply should result in upward pressure on bond yields. However, Canada’s two‑year yield has remained below that of its U.S. equivalent for more than a year, and there are few signs of a change from this situation anytime soon.

“Markets seem oblivious to the substantial increase in Canadian federal government bond supply. This reflects demand that is still strong… With about a quarter of global sovereign bonds outstanding offering negative yields, it is not surprising that global investors are attracted to high‑quality, yet positive‑yielding issues,” says Jean.

The Desjardin economist observes further that bond markets are currently in a state of overvaluation, which is exacerbated by the current situation with Canadian bonds. He sees this as a non-ideal state that will collapse once bond yields start going back up.

“If for any reason an upward movement in yields were to be orchestrated, realigning bond market valuations to some concept of equilibrium, Canadian debt securities might be vulnerable, especially given their abundant supply. The question is of course: what will be the catalyst to an escalation in yields[?]”
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