The S&P TSX composite index screen at the TMX Market Centre in downtown Toronto on Nov. 11, 2022.Tijana Martin/The Canadian Press
The world loves Canadian bonds at the moment. Not too crazy about our stock market though.
International investors scooped up a net $121-billion of Canadian bonds over the 12 months up to the end of June, according to the latest data on international transactions in securities from Statistics Canada. This builds on a trend of heavy foreign involvement in the Canadian bond market since the pandemic began.
At the same time, the international appetite for Canadian equities has faded. Foreign investors reduced their holdings of Canadian stocks by $45-billion over the past year, with net selling seen in seven consecutive months.
The diverging trends speak to the economic uncertainties of the moment. The threat of a recession particularly penalizes the Canadian stock market. That’s the downside of being dominant in the natural resource and banking industries.
“Foreign investors also shied away from Canadian stocks during the Great Recession and pandemic shutdowns – periods of high economic uncertainty,” said Sal Guatieri, a senior economist at BMO Capital Markets.
Those past economic bombshells, however, didn’t seem to sour the overseas investor on Canadian bonds. This time, too, vast pools of foreign capital have remained available to Canadian issuers.
That’s partly out of necessity. When the pandemic hit, the Bank of Canada started an emergency bond-buying program to inject cash into financial markets. The central bank is now reducing those holdings, including $350-billion worth of federal bonds, leaving a gap to be filled.
“Governments need to find end investors that want to hold their paper now that central banks are no longer vacuuming up all the supply that’s hitting the market,” said Warren Lovely, chief rates and public-sector strategist with National Bank of Canada.
For the first time in roughly three years, international investors hold a larger share of Canadian federal bonds than the Bank of Canada.
That international reception for Canadian sovereign debt contrasts with the pressure on U.S. Treasuries lately. In August, Fitch Ratings downgraded the U.S. government’s credit rating over concerns about the country’s fiscal position.
The U.S. budget deficit is expected to top US$1.5-trillion this year, while the government’s debt-to-GDP ratio is projected to rise to 118 per cent in the next two years – 2.5 times the debt ratio for the average triple-A-rated bond issuer, according to Fitch.
Meanwhile, the two largest holders of U.S. government bonds – Japan and China – have been less voracious in their stockpiling of Treasuries. Their combined US$2-trillion hoard as of June amounted to about 8 per cent of the outstanding total – a record low and less than one-third of the peak of 25 per cent reached in 2007.
“Canada hasn’t really fallen victim to the same kind of anxiety attached to our sovereign,” Mr. Lovely said.
“While Canada’s credit fundamentals may not be absolutely perfect, Canada possesses a lot of fiscal advantages versus the U.S,” he said. Canada has the lowest net debt load as a proportion of its economy of all of the G7 countries, according to the International Monetary Fund.
Canadian businesses have also eagerly chased international money, with corporate bonds responsible for $93.1-billion in net buying by foreign investors over the past year – roughly three-quarters of the national total.
The big banks have been a main player in this borrowing spree. There are good reasons for them to look beyond Canada’s borders for funding. They may be able to borrow on better terms in the United States and overseas. And flooding the Canadian market with debt could inflate bond yields and widen credit spreads, which translate to higher borrowing costs – and lower profits – for banks.
Canadian bank stocks, on the other hand, don’t have the same global appeal as bank bonds. In June, non-residents sold $3.9-billion worth of Canadian stocks, with the selling focused on bank shares, according to Statscan.
With another round of quarterly bank earnings scheduled to start this week, the big banks are under pressure. Slower loan growth, lower profit margins, and higher reserves for bad loans are expected to weigh on results.