MFA’s Corner

the government bond landscape in canada

The Government bond market in Canada is a vital building block for fixed income investors. The Government of Canada, the provinces and agencies of those governments are the major constituents of this market (municipal issuance is only a small component. Debt issued by this segment is generally considered high-quality and liquid, making it desirable for various portfolio needs. Early in 2020 it became clear low oil prices and fallout from COVID-19 would have sizeable impacts on government finances. Uncertainty swirled around governments’ ability to refinance their debt, potential ‘ratings actions’ and the associated impact on the value of debt and ultimately the necessity to finance looming deficits. Aided by various support programs provided by the Bank of Canada, after a brief period of volatility in March/April 2020, investor appetite for Canadian government debt rebounded quickly and remains strong. The market absorbed an estimated $338.8 billion of new Federal/Provincial debt in 2020 along with $5.6 billion of municipal debt.

The credit quality of Canadian government issuers, as measured by ratings, remains strong (Table 1). An equally weighted composite of provincial credit ratings remains near and above AA-, a level it has maintained since 2007. Meanwhile, on average, Canada continues to maintain its AAA rating. Although ratings remain high-quality, some governments’ ratings have been put on a negative watch or outlook, which can be interpreted as an intermediate step before a potential ‘letter-rating’ change. Rating agencies have indicated they are focused on medium-term financial plans, they will be closely following fiscal projections and core debt ratios. Due to that, investors can take some cues from the market’s reception to government fiscal policy announcements. Fiscal policy decisions which suggest debt levels in excess of ratios deemed acceptable at certain credit ratings or continued outsized deficits could lead to ratings downgrades. Despite the negative trend in core government credit measures, most investors believe outright defaults in the government bond space to be extremely unlikely, even for highly indebted and challenged provincial governments such a Newfoundland and Labrador who rely heavily on resources revenues.

In contrast municipal debt issuance was modest, as borrowing by local governments is almost exclusively done for long-term capital expenditures (not to pay for deficits). Municipalities rightsized their budgets in the face of the pandemic and maintained their high credit ratings, thereby becoming rarified issuers with stable credit quality. As a result, AAA-rated MFA bonds now trade at the same level as the Province of Ontario (the most liquid benchmark) and at better levels than almost every other province, except for the Province of BC.

From another perspective, the weight of the $338.8 billion 2020 government issuance had an impact on index proportions. Indices are used both for performance benchmarking and portfolio construction. A broad index of Canadian debt is the FTSE Canada Bond Index – which includes government, financial and non-financial issuers. Governments increased their relative size in the Canadian bond index by about 1.5% percent in 2020 to about 73.5% of the index – with the provinces leading the way, increasing their share by about 2.2% to 37.5%.

Due to their liquidity and high credit quality, government debt will continue to play an integral role in MFA’s Pooled Investment Funds. MFA’s professionally managed funds provide well-diversified exposure to the Canadian debt markets at a low cost. MFA has several investment funds to suit common local government investment needs. We would be pleased to discuss your investment program, our investment offerings and anything in between. •

KYLE DERRICK is the Credit & Economic Analyst at MFA. He is an MBA graduate from Royal Roads University and a CFA Level 1 Candidate. Mr. Derrick earned an undergraduate degree in Business Administration (Finance) and holds certificates in Economics and Bank Analysis.