Behind eye-popping headline figures on bond purchases is Big Six banks' aggressive activity within foreign currency markets
The monthly international transactions in securities release remains one of the more confusing and obscure Canadian data releases. As a result, stated headline figures tend to raise eyebrows and stoke curiosity. The same can be said about the release for the reference month of March 2022.
In a recent report for National Bank Financial, Warren Lovely turned his attention to a recent headline from Statistics Canada, which noted how “international transactions in securities generated an unprecedented net inflow of funds [in March and Q1].” The extraordinary net portfolio capital inflow into Canada consisted of some $70 billion in March alone, and roughly $120 billion in total for the first quarter.
While he was careful not to downplay non-resident interest in Canadian stocks, Lovely noted that the bond market was where most of the action was. Bonds accounted for $30.3 billion in foreign investment in Canadian securities in March, or nearly two-thirds of overall foreign investment in Canadian securities. Bond activity was even more dominant throughout the first quarter overall, accounting for 96% of net foreign investment.
“You might get the impression that non-residents were … pouring into Canada’s domestic bond market and soaking up product wherever and whenever it was found,” he said. “But that’s simply not the case.”
Lovely explained that even if the securities in question are not issued domestically – they were traded on the worldwide market rather than in Canada – StatCan still tracks them as foreign purchases of 'Canadian' assets.
In March, non-residents bought almost $30 billion in 'Canadian' bonds, although only $500 million (less than 2%) was in the form of CAD-denominated paper. The real foreign bond-buying, Lovely said, was taking place in the US dollar market ($17.5 billion in net Canadian product purchases in March) and other foreign bond markets ($12.3 billion in net purchases in March).
Non-residents were mostly purchasing Canadian bank paper issued in March (and for the previous several months) abroad. Including March's large sum, Canada's private firms, particularly banks, have raised over $150 billion from foreign investors in the past year.
That surpasses the previous high and effectively triples the net foreign finance acquired by all other Canadian issuers combined (including federal and provincial governments, who have significant deficits and capital spending requirements).
To explain why Canadian banks have been so active in their funding, Lovely noted that bank loans continued to grow through March, while deposit growth slowed. To fill the gap between those two activities, he said, capital market financing was necessary, through U.S. acquisitions and share buybacks in some cases.
It's also possible that some banks took advantage of the opportunity to get more funding ahead of the Bank of Canada's QT program that started in April, Lovely said, noting that the program would progressively drain liquidity and deposits from the system.
As Canadian banks were eager to tap international currency markets, Lovely said that investors were fortunately willing to provide the funding banks sought, even though “enthusiasm varied with underlying financial conditions/risk sentiment.”
He noted that the capacity to obtain money from international markets, by virtue of simple mathematics, limits the amount of bonds that are rolled out in the domestic bond market. The diversionary strategy, he added, serves to shield domestic spreads, and is used by banks as well as provincial governments across Canada.
“So even if headlines are a bit misleading and most of the foreign buying was happening south of the border and/or across the pond, there’s nonetheless an indirect benefit to domestic bonds from what has been a truly extraordinary amount of foreign engagement in Canada,” Lovely said.
