Group that advises the Bank of Canada on debt markets is livid over Freeland's decision to scrap inflation-adjusted bonds
Minutes of Canadian Fixed-Income Forum show members venting their frustration with a decision few saw coming
A group of fixed-income investors overseen by the Bank of Canada is livid over Finance Minister Chrystia Freeland’s decision to cancel a series of inflation-protected bonds.
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Group that advises the Bank of Canada on debt markets is livid over Freeland's decision to scrap inflation-adjusted bonds Back to video
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The minutes of the most recent meeting of the Canadian Fixed-Income Forum explicitly state that members “disagreed with the government’s reasons” for ending the issuance of real return bonds (RRBs), which are a useful hedge against inflation for pension funds and other institutional investors because the yield is linked to changes in the consumer price index.
“All (members) strongly agreed that inflation indexed-linked bonds are a very important asset class that serves a crucial role in allowing Canadian investors to manage their exposure to inflation and, in a well-functioning market, provides central banks and markets participants with an important measure of inflation expectations,” the group said in the minutes of its Nov. 29 meeting, which the Bank of Canada published on its website on Dec. 16.
“With the decision to eliminate new RRB issuance, market participants lost a way to express their inflation views and some members enunciated that the decision may create a perception that the government may not have full confidence in containing inflation.”
Canada is now the only G7 country not issuing new sovereign inflation index-linked bonds
Minutes
The minutes clearly state that Bank of Canada officials recused themselves from the discussion of RRBs because the central bank manages the federal government’s debt strategy. The members from Bay Street, on the other hand, appear to have shown up for the meeting in a mood to vent their frustrations with a decision that few saw coming.
“For retail and institutional investors, the cancellation removes a risk-free security that helps them manage short and longer-term inflation risks,” the minutes said. “Several members noted that demand for RRBs has increased across the curve in the current higher inflationary environment and is expected to increase further with the aging of the Canadian population. They also point to the fact that Canada is now the only G7 country not issuing new sovereign inflation index-linked bonds.”
The committee is co-chaired by Bank of Canada deputy governor Toni Gravelle and Jim Byrd, global head of rates trading at RBC Capital Markets, the investment banking arm of the Royal Bank of Canada. In total, the membership list includes 15 people, including representatives from Toronto-Dominion Bank, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, Bank of America and Canadian National Railway Co.’s investing division.
Inflation-protected debt is an important part of the modern financial system because financial institutions base their lending on the price and availability of risk-free assets. That didn’t stop Freeland from abruptly cancelling the Government of Canada’s real return bond program with little explanation in her November fiscal update.
“The government has decided to cease issuance of real return bonds effective immediately,” the Finance Department said in an update to its debt-management strategy. “This decision reflects low demand for this product and will allow the government to promote liquidity by consolidating funding within our core funding sectors.”
Low demand probably was related to the long period of muted inflation that followed the Great Recession. Central banks kept benchmark interest rates pinned near zero for the better part of a decade out of fear that weak economic growth could morph into protracted disinflation. There was little need for investors to pay extra to hedge against inflation when there was none.
But the backdrop has now changed. Canada’s headline inflation surged to 8.1 per cent in June, and continues to hover around seven per cent, the highest levels since the early 1980s.
“Members disagreed that liquidity for RRBs was an issue material enough to cancel the program,” the minutes said. “Most noted that while it is somewhat worse than liquidity for nominal (Government of Canada) bonds, they are still able to transact in quantities they need. Some members felt that RRB liquidity is generally better relative to inflation index-linked bonds in several other jurisdictions, for example the U.K.”
The minutes on the discussion related to RRBs took up an entire page, while most other concerns required only a paragraph.
“Many members” of the committee expressed “major concern” over a lack of consultation and transparency around why the decision was made. One member said Finance had just completed a consultation on the debt strategy and no questions about ending the RRB program were asked. Members described the characterization of RRBs in the fiscal update as “overly negative” and an inaccurate reflection of Bay Street’s views.
The committee “unanimously agreed” that Freeland should reconsider, as the sudden scrapping of RRBs in the wake of the government’s “unexpected” decision to stop issuing ultra-long bonds earlier this year could undermine confidence in the market for Canadian debt.
Some members felt that Freeland’s handling of the government’s debt strategy “could lead to less demand or participation in the whole (Government of Canada) bond market going forward, and ultimately resulting in higher borrowing costs for the government than any potential cost saving it could get with the cessation of RRB issuance.”
For now, the government is unmoved by the complaints and criticism.
“Demand for this sector is too low to justify maintaining it,” Marie-France Faucher, a spokesperson for the Finance Department, said in an email. “The government undertook extensive consultations in 2019, which showed poor demand for real return bonds. This was reinforced in recent debt management strategy consultations.”
• Email: kcarmichael@postmedia.com | Twitter: carmichaelkevin
