One man’s loss is another’s gain, as they say. And as the current situation in the bond market shows, the maxim applies equally to entire countries and markets.
According to an economic analysis by Warren Lovely, managing director and head of Public Sector Research and Strategy at National Bank Financial, a worldwide trend of decreasing interest rates has spurred bond investors to go on a hunt for higher yields—leading them to Canada.
“Non-residents were aggressively adding to their positions in Canadian portfolio securities before ‘Brexit’ turmoil and the latest bout of yield compression,” says Lovely. “Now, with more of the globe looking uncertain and/or providing scant yield, non-resident participation in Canada’s bond market may have only one way to go: and that’s up.”
Canada’s sovereign bonds have always been attractive to non-residents, and they are only getting more desirable. The securities offer a rare combination of qualities: a top-notch credit rating, demonstrated secondary market liquidity, and relative political stability. Considering bonds of up to ive years, “there is no larger developed country that can compete with the sovereign yields Canada offers.”
Canada mortgage bonds (CMBs) are also appealing to investors because they are guaranteed to timely payment of principal and interest by the sovereign. CMBs also demonstrate decent secondary market liquidity: considering outstanding bonds that are set to mature within 5 years, the average size of fixed-rate issues tops $7 billion, which is not so far from the average float of $11 billion for 5-year and in Government of Canada (GoC) bonds.
The piece also reports heightened demand for provincial bonds among international investors. “With 20% of their total debt stock denominated in foreign currencies, provincial issuers have long had exposure to foreign investors… But foreign investors today hold some $70 billion of domestic provincials—twice the amount owned before the crisis.”
The municipal bond market is only a fraction of the size of the provincial market, though it is also getting some interest from non-residents. The percentage share of Canadian municipal bonds held outside the country has risen over the years, and a rise in non-resident trading volumes has also been observed.
The analysis also notes that “foreign investors hold more Canadian corporate bonds than they do Canadas, federal crowns, provincials and municipals combined,” though this can be attributed to the fact that around 90% of corporate-issued paper is denominated in foreign currencies.
All these observations seem to indicate good news for Canadian issuers, but Lovely is careful to maintain a sober view. “While adding more investors to a given market theoretically means more potential outlets for trading, it’s not clear that the addition of numerous non-resident accounts has materially bolstered market liquidity. Indeed, one could argue that concentrating more of our bonds in the hands of foreign investors has led to less predictable, more volatile market making conditions.”
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