'There will be another round of austerity' to pay down mounting federal debt: Former PBO
The Canadian government is considering a shift to longer-term borrowing to finance a ballooning budget deficit, a strategy that would help it reduce potential pitfalls associated with short-term debt but which could also disrupt the balance in the country’s bond markets.
The government’s massive spending program to counteract the coronavirus pandemic has mostly been funded with shorter-term debt, a situation that carries elevated risk because when the time comes to refinance, “appetite might not be there or the yield may be much higher given the market knows it has to take down so much supply” according to Ian Pollick, global head of FICC strategy at Canadian Imperial Bank of Commerce.
Issuing the same amount of debt but with a longer maturity means the government would have “a longer time to worry about it,” Pollick said by email, adding the amount of bonds being issued to finance the budget deficit is reaching “extremes” and may cause “supply indigestion.”
Finance Minister Bill Morneau told lawmakers late Tuesday the government is assessing whether to shift strategy in a way that would mean additional issuance of longer-dated government bonds. “As we incur more debt, we are looking at extending the term and duration of our debt in order to provide us with less rollover risk,” Morneau said in Ottawa.
Pollick estimates there’s a 25-per-cent chance the government begins increasing the size of longer-dated auctions in the July to September period, though a more realistic approach is that the reorientation begins in the quarter after that. Canada could introduce a “real” 7-year bond, similar to the U.S., or boost issuance of 10-year debt, he said.
Canada will auction more than $100 billion of fresh government bonds in the coming quarter, which is an “unprecedented tally,” according to “guesstimates” by Warren Lovely and Taylor Schleich at National Bank Financial. However, stripping out the Bank of Canada’s allotment at auction and QE-related purchases, as well as further adjusting for maturities, “the remaining net issuance might be around $18 billion for the quarter,” they said.
Massive spending measures are already having an impact on Canada’s creditworthiness. Fitch Ratings cut the country’s long-term debt rating on Wednesday to AA+, from AAA, citing a deterioration in public finances resulting from Covid-19 spending. Countries with lower credit ratings usually pay more to borrow.
Morneau’s strategy of extending duration, if put into place, could disrupt the broader market, as “terming out the debt begins to destabilize the ecosystem of issuance” between government and corporate borrowers, Pollick said. That “raises the likelihood that a crowding out dynamic develops,” meaning provincial and corporate borrowers may need to pay more to issue longer-term debt.
It could also increase the permanence of the Bank of Canada’s quantitative easing program, since purchases by the central bank will need to continue and perhaps be more targeted to the back end, he said.
Morneau has so far declined to give an estimate for how far into the red Ottawa will need to go to fund its income-support, wage-subsidy and other pandemic-related programs. The Parliamentary Budget Officer predicts Canada’s budget deficit will reach $256 billion this fiscal year. Morneau is due give a “fiscal snapshot” on July 8.