Strong foreign demand for Canadian stocks and bonds

Foreigners bought a net $11.8-billion of Canadian stocks and bonds in January, according to a Statistics Canada report Thursday. That includes $10-billion of bonds, about two-thirds of which were issued by the federal government to finance spending aimed at boosting the economic recovery. It was the third straight month of huge purchases of Canadian securities by international investors, who in 2009 bought a total of $110-billion of Canadian securities including a record amount of bonds.

Demand is so high both from abroad and within Canada that money managers are “starved for product,” said David Baskin of Toronto's Baskin Financial Services. The attraction among investors to Canada could stay red-hot, he added, as long as it appears the Canadian dollar will gain or hold firm against other currencies.
Foreign investors in particular are eyeing Canada, though the country is not as dependent on investment from abroad to meet its financing needs as other nations are. In the United States, almost half the bonds available to non-government investors are held by people in other countries, such as China and Japan.
While both Canada and the U.S. are running large deficits, Canada's is substantially smaller even on a per capita basis.

And while Canada is now running a current account deficit, by definition requiring some foreign capital to fill the gap, Canadians share the global preference for their country's securities over those of other nations. In January alone, Canadian investors dumped a net $5.8-billion of foreign stocks and bonds. Money managers are often frustrated by the relatively scarce amount of government bonds available – a product of the record-setting run of 11 successive budget surpluses that whittled the country's debt down sharply.
“Investors get attracted to strong things, and we are in that camp now,” Adrian Mastracci, a portfolio manager at KCM Wealth Management in Vancouver.

The high level of demand at home and overseas is both driven by and contributes to the Canadian dollar being ever so close to parity with its U.S. counterpart. And it means Canadian governments issuing debt can pay less to the investors buying it when the securities mature.
Canada's current budget shortfall is 3.5 per cent of gross domestic product, compared with almost 11 per cent in the U.S., and as a result the U.S. government's interest payments are on track to increase by 170 per cent over the next five years while Canada's will stay essentially flat.

“It helps Canada in keeping some of those government expenses down, but on the other hand those in Canada that want to be bondholders may not be able to get the total allocation they're looking for,” Mr. Mastracci said.

Mr. Baskin reckons that demand could stay strong about six months, at which point the loonie's strength against the U.S. dollar may recede as the American economy improves and the Federal Reserve prepares to start raising interest rates if it hasn't done so by then.
According to the debt management strategy the government released earlier this month with the budget, the Finance Department will sell $95-billion of bonds in the fiscal year beginning April 1, less than the $102-billion in the current year but about 20 per cent more than many economists expected, according to a survey done by Bloomberg.

The $111-billion 12-month net foreign purchase of Canadian securities is more than enough to fund government borrowing and about triple last year's $41-billion current account deficit, Bank of Montreal deputy chief economist Douglas Porter noted.
However, the fact it's easy for Canadian governments to borrow could eventually encourage some to overspend, he said.

“Oftentimes investors will give you enough rope to hang yourself,” Mr. Porter said. “`In some ways, if it's so easy to finance a deficit, there isn't the pressure on governments to pull in the reins.''