FTSE Russell execs explain how Canada’s conservatism has benefited the Canadian bond market while offering a global outlook
During December’s small political crisis, the Canadian government announced a budget deficit of over $60 billion, blowing through its targeted limit of $40 billion. Despite the size of those numbers, and the political fallout of added deficit spending, international bond markets see Canada’s fiscal policy as relatively stable and even conservative.
Sandrine Soubeyran and Robin Marshall, both directors of Global Investment Research at FTSE Russell, highlight several factors that are playing into how Canada’s fiscal discipline has helped differentiate its fixed income market from peers in the G7. They highlight the fact that deficit spending has skyrocketed globally, especially amongst developed economies. The International Monetary Fund projected last year that global public debt will exceed US $100 trillion by the end of 2024. In that context, Marshall drives home the fact that Canada’s debt-to-GDP ratio is actually the lowest in the G7.
“You could argue that Canada is almost going down a slightly different route. It’s almost a rejection of Keynesianism. That might be overstating it, but it’s worth considering,” he says, pointing out that fiscal policy has become “more active” since the Covid-19 pandemic. “COVID required a very active fiscal support operation from these G7 countries, including Canada, when the public sector balance sheet was used to put a safety net under the global economies.”
Consequently, Marshall notes that while the US has continued to since ease fiscal policy, Canada has not, whereas the US has kept its fiscal stimulus in place, with deficits over 6 per cent of gross domestic product (GDP). “Canada has shown a desire to consolidate and roll back more of that fiscal stimulus,” he says.
This fiscal restraint is not a new phenomenon but rather the legacy of Canada’s financial history, where the country, “to some extent, was scarred by this notion that it had become an irresponsible economy,” Marshall says, pointing to Canada’s fiscal crisis in the 1970s under former Prime Minister Pierre Trudeau.
Comparatively, Canada’s fiscal policies remain cautious in a global context as Soubeyran notes Europe has a similar fiscal rule which says deficits should be 3 per cent. “Yet, France is running at 6 per cent. It’s so high compared to Canada, she says. This conservatism has benefited Canadian bonds, which have avoided the significant selloffs seen in other markets. She points to Canada’s deliberate approach to balancing growth with fiscal responsibility.
“Looking at what they’re planning in government spending, it’s around $538 billion, only a couple of billion higher than this year,” she explains. “Debt per GDP is over 100 per cent but they’re clearly trying to rein that in and bring the whole financial situation into a much healthier state than elsewhere.”
The combination of fiscal prudence and aggressive monetary policy has created opportunities in the Canadian bond market, Marshall says, pointing to the strength of bond yields.
“In terms of what the policy consensus is, there’s no great appetite for a huge fiscal stimulus in Canada, which in turn, would raise the debt to GDP ratio significantly,” he says, noting that yields rallied last year but backed up again in the last two to three months, as Treasury yields have recently moved up sharply.
“Yields have been pretty attractive, even though spreads are quite a bit below the US,” leading to “a feral outperformance by Canada,” adds Marshall. “The Bank of Canada went in and eased policy well in advance of the Fed back in June of last year. There were initial fears about spreads, or the exchange rate being upset, but by and large, it’s played out well.”
Canada’s fiscal discipline has also contributed to its strong sovereign credit ratings, Soubeyran says, noting the debt levels in Canada aren’t anywhere near other countries. The Bank of Canada’s balance sheet, she notes, is at $230 billion, “compared to trillions in the US and Japan.” Meanwhile, Japan’s debt-to-GDP ratio currently sits at 263 per cent and the United States’ ratio is around 123 per cent.
Despite these strengths, the two emphasize that Canada’s fiscal policy cannot fully decouple from external pressures, especially if the US pursues aggressive fiscal policies, like tax cuts under Trump’s second term. “That could put upward pressure on US yields and somewhat pull up Canadian yields,” warns Marshall.
As Canada enters an election year, political changes could bring shifts to fiscal policy. And while Conservatives seem to be polling ahead, both Soubeyran and Marshall suggest that any policy changes would likely be modest. “It’s not like there’s going to be a violent swing in policies,” says Marshall. “The main drivers are going to continue to be growth, inflation and interest rate settings.”
