Foreign money is flooding into Canada like never before, helping to drive the yield on Canada's benchmark 10-year bond to a record low and sending rates plunging across the board.
Canada is among a small group of countries offering investors a sweet mix – perceived risk-free assets with some return – which could push government borrowing costs lower still.
Canada has long been a favoured country, but interest is growing again amid the global turmoil.
That's something of a mixed blessing, because while it drives down Ottawa's borrowing costs, it also threatens to juice the Canadian dollar even more at the same time that growth in key export markets is sputtering.
The yield on federal government 10-year bonds fell Monday to a record low of just under 1.6 per cent. This came on the same day that Statistics Canada reported record purchases of Canadian securities by foreign investors in May. Those foreign players picked up a record $26.1-billion of Canadian securities two months ago, $16.7-billion of which were government bonds.
Rates on other federal government bonds have also nosedived of late.
"Investors are looking for something that gives them a bit of yield, but with no risk, and there are only a few places like this now," said Denis Senecal, vice-president and head of fixed-income investing at the Canadian arm of Boston-based State Street Global Advisors.
"It's not so much, 'We want to have Canada in our funds.' It's more, 'We don't want any risk, so what's out there that gives us a bit of return and low risk?'"
Investors have been attracted to Canadian securities through much of the recovery because of the country's economic and fiscal standing compared to its peers.
Canada is a much bigger market than other ultra-creditworthy "havens" like Australia, Norway and Sweden, making the country a natural target for big investors looking to diversify their holdings away from riskier assets.
And even as U.S. Treasuries set records – 10-year government bonds south of the border still have lower yields than Canada's, dipping below 1.45 per cent Monday – analysts say some investors are becoming less eager to buy American, given the weakness of the U.S. economy and anxiety about the effects of post-election fiscal belt-tightening.
Charles St-Arnaud, an economist with Nomura Securities in New York, said the most telling aspect of the recent surge in demand for Canadian securities is that unlike previous episodes – last July during the political standoff in Washington over the U.S. debt ceiling, and in late fall, as the euro crisis intensified – much of the investment has been in bonds rather than short-term money-market paper.
"Instead of seeing Canada as a quick 'hide-and-seek,' they're willing to take that position as a safe investment for their money," he said, adding that federal bond yields this low could allow the Harper government to wipe out its deficit more quickly than anticipated or, if necessary, to slow the pace of spending restraint to support the economy.
"Given the size of the debt, it's a massive savings," Mr. St-Arnaud said.
Yields could fall further, he said, when you consider that foreign ownership of Canadian federal government bonds is at about 30 per cent – compared with 15 per cent before the financial crisis, but nowhere near the 85-per-cent level in Australia. That means there is plenty of room to accommodate more investment from outside the country.
However, there are risks associated with Canada's darling status among global investors.
According to Mr. St-Arnaud's analysis, every $10-billion of net inflows into Canada leads to a roughly 0.7-per-cent gain in the Canadian dollar, which helps explain why the currency has not fallen in lockstep with oil prices. (In May, for instance, the loonie fell 5.3 per cent against the U.S. dollar, but oil plunged about 20 per cent.)
With global demand on life support, a stronger currency could be damaging for Canada's export-dependent economy. Bank of Canada Governor Mark Carney – who will make an interest-rate decision Tuesday and is scheduled to release a new economic forecast Wednesday, and who already has predicted that investors will be drawn to Canada for at least a decade as other advanced economies flag – will be watching these flows closely, analysts said.
Also, some observers worry that since lower government bond yields influence borrowing costs elsewhere in the economy, Canadians' tendency of recent years to gorge on debt could be re-ignited just as it's being tamed.
"For a country like Canada that saves too little relative to consumption," Ian Pollick of RBC Dominion Securities wrote last week in a research note on Canada's growing haven status, "lower borrowing rates may extend the recent buildup of imbalances, thereby threatening to borrow too much demand from future business cycles."