Like Canadian homebuyers, Ottawa bets on historically low interest rates as it racks up record debt

Like homebuyers gambling on floating-rate mortgages rather than locking in more expensive fixed rates, Canada is betting it may cut costs by borrowing short-term because it issues an archive $133 billion in debt to finance an ambitious spending program.

“We’ve remained open to the glory of issuing longer-term bonds,” Finance Minister Bill Morneau said within an interview Wednesday at Bloomberg’s headquarters in New York. “At this time the majority of our issuance is really in the two, three, five, seven years, and that’s according to where we see the financing opportunities and the appropriate cost for all of us at this time.”

By concentrating on short-dated maturities, Morneau is wagering that the historically low interest rates which have dominated the global economy will not drift too high. The finance minister and the Liberal government of Prime Minister Justin Trudeau delivered a financial budget on March 22 that featured big spending on social programs and infrastructure contributing to $120 billion in cumulative deficits in the next six years.

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So far, the bond market will follow Morneau’s thinking. Canadian government bonds rallied across the curve in the days following the budget, making theme the second-best performing among their Number of Seven peers as markets cut back expectations for a rate rise from the U.S. Federal Reserve. The yield around the Canadian two-year government bonds dropped to 0.54 per cent from an average of 0.98 per cent in the last 5 years. Yields on Canada’s benchmark 30-year bond have fallen to 2 percent from an average of 2.62 per cent over the past five years.

Flat Curve



“The yield curve is so flat they probably think they can roll it on the couple of times before they run into more expensive of debt-servicing,” Raymond Humphrey, who manages $8.5 billion in Canadian assets for AllianceBernstein Holding LP, said by phone from Ny. “You as a consumer, should you saw those rates, should you be in a position to finance yourself cheaply for a house for 2 years or pay triple or quadruple for 3 decades, which may you choose?”

The bond marketplace is currently pricing interest rates to be about the same in 2 years, Humphrey said. If they do rise, it will likely be as a result of better economic growth, which would still be victory for that government. Morneau is likely “not really concerned about rates of interest getting away from him,” he said.

Provincial Crowding

A concentrate on short-dated maturities is suitable considering the government is planning $4 billion in new infrastructure spending in 2016-2017, Stefane Marion, chief economist at National Bank Financial, said by phone from Montreal. Most of the 2016-2017 issuance is going to be used to refinance $92 billion of old debt.

“With respect to infrastructure spending, people might say they should match duration – they should issue in the long end of the curve,” he said. “I would reason that issuing in the short end of the curve right now makes sense because of the size of the infrastructure program.”

The federal government can also be concentrating on two, three, and five-year bonds to prevent crowding out provincial issuers, who have a tendency to issue in the long end, he said.

Canada followed an austerity course revisit balanced budgets under former Pm Stephen Harper. The brand new government’s use of deficit-spending to help drive growth, and it is refusal to commit to a period for returning to balance, has raised concern the country’s debt to GDP ratio, may balloon. It currently stands at about 31 percent, the cheapest within the G-7.

Hard Work

“We were here a dozen years back it had been hard work to rebalance,” Humphrey said. “It’s always good once the government is making investments that improve GDP within the longer haul but the worry is the fact that they’re spending cash because they can, with little to show for this.”

National Bank’s Marion thinks the emphasis on short maturities is a signal that Canada won’t be going back to structural deficits.

“By issuing at the shorter end from the curve, in my experience it’s a message that we don’t intend to run structural deficits,” he said.

Bloomberg News