Bond investors count on Canada to chart fiscal path back to normal – Reuters Canada

TORONTO (Reuters) – As Canada rolls out additional spending to support its economy during a second wave of the coronavirus, bond investors are giving Ottawa “the benefit of the doubt,” expecting a historic budget deficit to be slashed once the pandemic subsides.

FILE PHOTO: A Canadian flag flies in front of the Peace Tower on Parliament Hill in Ottawa, Ontario, Canada, March 22, 2017. REUTERS/Chris Wattie/File Photo

The Liberal Party government of Prime Minister Justin Trudeau projects that the budget deficit will shrink to C$25 billion ($19.3 billion) in 2025-26, less than 1% of GDP, after surging to an expected C$382 billion this year, as emergency aid mostly ends and the economy recovers, a fiscal update showed on Monday.

A credible deficit reduction path could help keep Canada’s borrowing costs low and reassure credit rating agencies. Canada lost one of its coveted triple-A ratings in June, when it was downgraded by Fitch Ratings.

Bond investors for now will probably give Ottawa “the benefit of the doubt,” said Vinayak Seshasayee, head of Canada portfolio management at PIMCO.

“We don’t expect that the bond market will sharply raise borrowing costs for the government because I think there is belief that in the long-term those deficits will be reined in,” Seshasayee said.

At 1.22% on Tuesday, the yield on Canada’s 30-year bond was trading 4 basis points further below its U.S. equivalent at a spread of 43 basis points, while the Canadian dollar strengthened 0.4% to 1.2950 per U.S. dollar, or 77.22 U.S. cents.

Despite an expected increase in government debt by more than 50% to C$1.1 trillion, Canada’s debt servicing costs are projected to fall below 1% of GDP in 2020-21, their lowest level in over a century, helped by record-low interest rates from the Bank of Canada and a large-scale asset purchase program that the central bank launched for the first time.

“I think the bond market would probably be a little more tentative if the central banks, like the Bank of Canada, the Fed, or the ECB were not in the market buying newly issued securities from the government to finance the deficits,” said Darcy Briggs, a portfolio manager at Franklin Templeton Canada.

The Bank of Canada has shifted its asset purchases to buy more longer-term bonds. That could help Ottawa, which plans to raise the share of long-term debt it issues to 29% of bond issuance in 2020-21 from 15% in 2019-20, hoping to lock in historically low rates.

At C$407 billion, or nearly 19% of GDP, Canada’s fiscal response to the pandemic has been one of the largest in the G7. Still, Moody’s Investors Service last month affirmed Canada’s triple-A rating, saying the risk of a material, long-lasting deterioration to Canada’s economic or fiscal strength from the coronavirus crisis is low.

S&P Global Ratings and DBRS Morningstar also continue to give Canada their highest rating.

What credit rating agencies “will all be looking for is a credible medium-term plan in getting directionally back towards balance and this (fiscal update) at a minimum shows that,” said Craig Wright, chief economist at Royal Bank of Canada.

Reporting by Fergal Smith in Toronto; Editing by Denny Thomas and Matthew Lewis

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