In this Off the Cuff video, Geoff Johnston discusses the recent credit downgrade for Canada.
As you may have heard, the credit rating of the Government of Canada was just downgraded by Fitch Ratings from AAA to AA due to concerns about Canada’s rising debt and deficit levels.
Many investors are very concerned about what this means for their Canadian investments, especially Canadian bonds. The biggest question they have is about Canadian borrowing costs. Is this downgrade going to cause an increase in borrowing costs?
We don’t believe Canada’s federal debt situation is nearly as bad as it seems.
For starters, Canada has only been downgraded by one rating agency and that is Fitch. The big ones are S&P, Moody’s and, in Canada, DBRS. All these rating agencies still rate Canada AAA. Granted, Fitch could simply be the start of a trend and other rating agencies could follow suit. But even the consequences to our borrowing costs should be minimal, and this is the main point I want to get across here:
Canada is the sovereign issuer of its own currency. In other words, the Canadian government debt is almost entirely in Canadian dollars, which it controls. What does this mean? It means that the Canadian government could pay off all its debt tomorrow in one giant Quantitative Easing (QE) program.
Won’t this cause inflation? No. If QE caused inflation, we would have it by now. In fact, we have deflation based on the latest stats. The reason why QE doesn’t cause inflation is that it is basically just a swap of cash for bonds. There is no increase in overall financial assets in the system. For example, if you had $10,000 worth of Canada bonds and I was the Bank of Canada, you would give me the bonds and I would give you $10,000 in cash. Would you be better off? No, your assets would still be $10,000. The only difference is that now you have cash instead of bonds. You are no richer and your spending power has not increased. This is why QE does not cause inflation.
The bond market is well aware of this. This is why our bond yields remain very low with 10 years at 50bps and our 30 year bond is below 1.00% - which is actually lower now than before the downgrade! A similar situation happened in the USA. When they were downgraded in 2011, bond yields fell afterwards.
Lastly, Japanese debt levels are far higher than ours. I believe Japan’s debt/GDP ratio is north of 200% versus less than 100% for Canada. Yet, their bond yields are zero because they are also a sovereign debt issuer.
The bottom line is that Canada’s debt situation is not as bad as it seems. There are plenty of things to worry about these days, especially health-wise, but Canada’s credit worthiness is not one of them, or at least it should be far down the list of concerns!
I hope this helps. Thanks for listening and good luck out there.
Segregated Fund contracts are issued by The Empire Life Insurance Company (“Empire Life”). A description of the key features of the individual variable insurance contract is contained in the Information Folder for the product being considered. Any amount that is allocated to a segregated fund is invested at the risk of the contract owner and may increase or decrease in value. Past performance is no guarantee of future performance. All returns are calculated after taking expenses, management and administration fees into account.
This document includes forward-looking information that is based on the opinions and views of Empire Life Investments Inc. as of the date stated and is subject to change without notice. This information should not be considered a recommendation to buy or sell nor should it be relied upon as investment, tax or legal advice. Information contained in this report has been obtained from third party sources believed to be reliable, but accuracy cannot be guaranteed. Empire Life Investments Inc. and its affiliates do not warrant or make any representations regarding the use or the results of the information contained herein in terms of its correctness, accuracy, timeliness, reliability, or otherwise, and does not accept any responsibility for any loss or damage that results from its use. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.
Empire Life Investments Inc. is the Manager of the Empire Life Emblem Portfolios and Empire Life Mutual Funds (the “Portfolios” or “Funds”). The units of the Portfolios and Funds are available only in those jurisdictions where they may be lawfully offered for sale and therein only by persons permitted to sell such units.
June 29, 2020