Foreign investors haven't lost their appetite for Canadian securities. They may just be suffering from a bit of government-bond indigestion.
Statistics Canada reported Monday that foreigners trimmed their Canadian holdings of investment securities (stocks, bonds and money-market instruments) by $1.1-billion in June. Given that foreigners had piled into Canada to the tune of $31.6-billion in the previous two months combined, a step back was inevitable – and this is a relatively modest one.
But more notable, even a little alarming, was that this downturn included the sale of a net $11.9-billion of government bonds – the biggest one-month exodus in the 26-year history of the data. And $9.6-billion of that came in an unprecedented sell-off of federal government bonds.
As dramatic as that move is, it can be seen as merely a continuation of a trend that has been going on for months now. Dating back to last December, foreigners have shed $18-billion of Canadian federal government debt. A $6.9-billion rebound in May that suggested the sell-off may have run its course, but June's numbers wiped that out and then some.
In the bigger picture, this doesn't look like a flight from Canada – but it does suggest that foreign buyers have become uncomfortable with the huge volumes of Canadian government paper they loaded onto their plates over the past several years, when the country's post-crisis stability and relative health made it a haven for gun-shy investors.
From the beginning of 2009 through the end of 2012, foreigners gobbled up a net $178-billion of Canadian government debt. That's a massive and unsustainable increase in exposure to Canada; at some point, that was destined to start unwinding.
The downturn in foreign holdings of government debt has accelerated since last fall – a shift in sentiment likely linked to the change of tone at the Bank of Canada.
The central bank shifted to a neutral policy stance in the fall, raising the possibility for the first time in years that its next interest-rate move could actually be a cut, rather than an increase. As inflation became dangerously low in the fourth quarter, the bank's tone grew even more dovish, and its outlook less optimistic. The signal to financial markets was that the prospect of higher interest rates (and thus rising returns) on risk-free investments in Canada, namely government bonds, has become more distant and less certain.
That signal hasn't changed much in the past few months, despite a rebound in Canadian inflation and signs of economic improvement. With other key central banks in the likes of the United States and Britain inching toward eventual rate increases, Canada's lagging rate outlook has provided more than adequate reason for investors to reduce some of their Canadian government bond exposure and place some bets elsewhere.
Yet outside of the government bonds, foreign investors still show loads of appetite for Canadian assets. They have turned increasingly to corporate bonds, where foreign holdings grew by $8-billion in June and nearly $24-billion in the first six months of the year. They have piled into the Canadian stock market, where foreign investment has increased 10 months in a row, by a total of $39-billion.
While some of that certainly reflects a search for better yields over the moribund government market, it also shows confidence that, despite the Bank of Canada's relentless caution, the Canadian economy is poised for accelerating growth. That's more than investors can say for some of Canada's key developed-market competition for securities investment, such as Europe and Australia.
The focus of foreigners' investment in the corporate sector is also telling: Much of it is being directed to energy issuers. The turmoil in the Middle East and Russia should underpin strong energy prices for some time, and Canada remains a bastion of energy exposure for international investors.
All of which suggests that despite foreign investors' recent distaste for Canadian government bonds, they still have compelling reasons to continue to put their money in Canada. A world of unappetizing options will keep money flowing Canada's way for a while yet – buying domestic markets time for the Bank of Canada's outlook to eventually warm up.
David Parkinson