Finance Minister Bill Morneau’s fiscal snapshot this afternoon has helped extend the loonie rally as the dollar broadly weakens towards the back-end of today’s session. Additionally, the Canadian government bond curve bear steepened as issuance numbers are set to rise at unprecedented rates; the 30Y yield rose 7.68bps vs the 1.5bp rally in the 2-year yield.
The announced budget deficit of C$343.2bn in 2020-21 equates to a shortfall of around 15.9% of GDP and outstrips economists estimates of a deficit of around C$250bn. The projections for the year even surpass the leaked estimates ran in the Globe and Mail this morning of a deficit at around C$300bn, but in the words of Prime Minister Trudeau; “we have decided to take on that debt to prevent Canadian’s from having to do it”. Despite the great depression level figures, the basis of Fitch’s credit downgrade seemingly factored in a realistic reading of Canada’s current ongoings. The credit agency anticipates a federal deficit of 16.1%, vs the 15.9% announced by the Treasury, and warrants the credit downgrade to AA+. However, the deterioration in government finances isn’t isolated to Canada, and markets are instead focusing on the effectiveness of the stimulus with respect to the incoming economic data.
On the surface, the fiscal and monetary response is akin to that seen elsewhere in developed markets, although the response to the Liberal government’s spending suggests the fiscal taps will begin to shut-off as opposed to tightening.
This is a gamble, especially as the scaling back of lockdown measures globally has seen localised outbreaks needing containment measures to be reinforced. The risks also mount as the recovery in the oil sector and Canada’s export market are subject to derailment should the US fail to curb its domestic outbreak and recover at a similar pace seen in other G10 economies. With the Bank of Canada reluctant to give markets any further guidance on going into negative rates, or even cutting below the effective lower bound of 0.2% for now, the emphasis will be on the balance sheet. With debt issuance spiking at the back-end of the curve especially, the central bank’s monetisation of the deficit will be of paramount importance, even if the Governing Council refuses to classify its C$5bn a week purchases as a QE operation.
Some more details on the deficit figures:
- Program expenses will surge 69% to C$592.6bn (27.5% of GDP) with the cost of the CERB program, Canada’s Emergency Response Benefit which has propped up household incomes, increasing to C$82.3bn – The cost is split with a C$7.4bn price tag in 2019-20, and C$73.1bn in 2020-21.
- The snapshot also saw the wage subsidy programe topped up by almost C$40bn to C$82.3bn. The CERW, Canada Emergency Wage Subsidy, is currently subsidising up to 75% of employees wages for up to 24 weeks (August 29th 2020) in order to increase job retentions as businesses look to bring workers back as lockdown measures ease. Canada’s unemployment rate currently sits at 13.7% as of May.
- Deficit is projected at C$343.2bn in 2020-21, with tax revenue seen declining by 21% to C$268.8bn – the biggest drop in tax receipts since the great depression.
- A further fiscal update is expected in the fall, with the current projections not made beyond 2020-21.
- 10-year and 30-year bonds are expected to rise to 18% and 8% of gross bond issuance in 2020-21 from 11% and 3%, highlighting the deepening of liquidity in the back-end of the curve. Annual gross bond issuance is planned to be around C$409bn this year.
New debt issuance is “prudent” and “spread out over the long term” but gives the BoC another task when tapering support mechanisms comes into scope – debt servicing costs
Canada’s yield curve bear steapens on the announcement as issuance is targeted towards the back-end
Despite the headlines, the loonie continued to chug along with its rally towards the 1.35 level as the dollar broadly weakens in today’s session. The EU giving aid programs from both Germany and Italy (€500bn and €6.2bn) the thumbs up today has helped support risk sentiment, while the second wave of fiscal stimulus and a falling positive case count in sunbelt states in the US has helped at the margin.
The emphasis now for the Canadian dollar will be on the labour market data due for release on Friday at 08:30ET.
Market participants will get the first taster on how the labour market recovered in June following a relatively upbeat Q2 Business Outlook Survey where over half of the firms surveyed expected employment levels to be back near pre-virus levels. Although, the true scarring inflicted on the labour market from the pandemic won’t be visible until support measures begin to taper.
Loonie trades near 1-month high as markets turn risk-on again and fiscal stimulus deemed inline with peers
Author: Simon Harvey, FX Market Analyst