Once a fiscal stalwart, Canada now appears vulnerable

Justin Trudeau’s government made every effort on Wednesday to convince Canadians the country can afford a deficit that will soar to 16 per cent of economic output this year. Its actions suggest there’s some worry.

In the same budget update that forecast a $343-billion deficit, Finance Minister Bill Morneau announced a significant shift in strategy toward issuing longer-dated bonds — a tacit acknowledgment the rising debt levels are making the nation’s finances more vulnerable to any rise in interest rates. The idea is to lock in as debt at current borrowing costs for as long as possible, to ensure public debt charges don’t surge in the future.

With federal debt surpassing $1 trillion for the first time ever, the risk is real. Rates are at historic lows today because of the global recession, but a recovery will drive them higher. If interest costs on public debt simply return to last year’s levels — when they equalled 3.4 per cent of debt — the federal interest payments would nearly double, according to Bloomberg calculations. That’s not taking into account the likelihood that large deficits will continue for years.

“The complacency is incredible since many pundits say the sustainability is solid because of ultra-low interest rates,” said David Rosenberg, founder of Rosenberg Research and Associates and former chief North American economist at Merrill Lynch & Co.

“The problem with that is the low interest rate regime reflects a future of very weak nominal growth, which in turn points to ever-weaker revenue generation.”

For now, the government emphasizes that borrowing is cheap. With rates falling to all-time lows, federal public debt charges are forecast to decline this year to just under $20 billion — the lowest since the 1980s — despite the enormous deficit.

Canada’s federal government still has fiscal capacity, at least compared to its provinces and other major advanced economies with higher debt-to-gdp ratios. Nor is Canada an outlier in a world of rising government debt. Everyone is borrowing.

The Bank of Canada, meanwhile, has been willing to mop up a lot of government bonds, via the creation of new money, easing financing strains on Trudeau’s government. The central bank is on a path to buy about $300-billion worth of bonds this fiscal year through its Large Scale Asset Purchase (LSAP) Program, and it continues to purchase 13 per cent of all primary market offerings of nominal bonds, TD Securities said.

“Even after our historic investments, Canada will continue to hold its low-debt advantage,” Morneau told lawmakers Wednesday in Ottawa. “This, combined with historically low interest rates, gave us the balance sheet to deploy our fiscal firepower to support Canadians through this.”

But in the debt management strategy of the budget document, the finance department sounds less sanguine.

The federal government announced plans to sell $106 billion of 10-year and 30-year bonds in the fiscal year that ends March 31, according to budget documents released Wednesday.

That’s more than six times the $17 billion of such bonds it sold last year as the government fights the recession caused by the COVID-19 pandemic, and shows the government’s desire not to be too dependent on shorter-term debt that would need to be refinanced in the next several years.

The coming flood of new longterm bonds pushed down the value of existing 10- and 30-year debt, with yields on the latter rising to nearly 1.1 per cent on Wednesday, according to Bloomberg data. The benchmark 30-year Canada bond was trading at a yield of 1.066 per cent on Thursday at 8:25 a.m. Ottawa time, up about eight basis points from Tuesday afternoon.

The government expects gross bond issuance of $409 billion this year. The total bond stock is projected to increase 53 per cent to $915 billion. The stock of Treasury bills is set to rise 94 per cent to $294 billion.

Foreign debt issuance will reach $26 billion, $10 billion more than at the end of March.