With the Bank of Canada announcing yesterday that Debt Management Strategy (DMS) Consultations for FY21/22 will begin in the Fall along with some accompanying questions, it’s an ideal time to look at the structure of Canada’s outstanding debt relative to its global peers. In the lead-up to COVID, Canada stood out as one of the few countries in the OECD to have shortened average term-to-maturity of its debt since 2007 (see attached 2019 chart from the OECD).
This shift was driven by two factors: 1) A relatively rapid return to a balanced budget in the aftermath of the 2008/09 financial crisis, and 2) A fully thought out decision to focus on shorter-term bond issuance when deficits returned in 2016 and beyond. On an outright basis, Canada went into this crisis with a below average term-to-maturity, relative to both recent history and to other major economies, presenting a clear opportunity and space to issue more long-term debt. In contrast to the drop in Canada’s average term-to-maturity of its debt stock, the weighted average term across the OECD has instead risen from 6.2 years in 2007 to almost 8 years now.
The DMS Consultations asks whether the government should consider new debt terms (i.e. 7-year, 20-year, 100-year) or whether they should focus on building out current maturities and further develop the 50-year sector. Given where interest rates are, it's tough to argue against issuing ultra-long bonds. The 7-year and 20-year sectors don't appear to be great options, with the provinces already moving into 7s, while the 20-year was historically the cheapest sector on the curve until the BoC came in to buy a chunky portion of the off-the-run bonds. An earlier foray into the sector (issuing $4.75 billion of 2064 bonds from 2014 through 2017) was well-received by markets. Indeed, the biggest hurdle for the 2064 bonds is the lack of liquidity due to the small issue size. Meantime, 100-year bonds should be worth a thought after seeing how some European countries have seen extremely strong demand and performance.
It’s notable that the current Debt Management Strategy has already moved to increase issuance at the longer end of the curve. For this fiscal year, 10-year issuance is up 465% and 30-year issuance is up 662% from last year, which will already begin to increase the average term-to-maturity. But we believe that more can be done on this front at these abnormally low long-term borrowing costs. For the rest of the curve, 2-year issuance is up 183%, 3-year 236%, and 5-year 165%.
One reason the government shied away from consistently issuing 2064s is that they viewed the cost as being too high relative to focusing on shorter durations. While that decision proved to be correct in light of the more recent collapse in yields, interest rates are at or near record lows currently, and it’s questionable whether rates can fall materially further. That’s especially the case with the Bank of Canada seemingly unwilling to move policy rates into negative territory. Accordingly, issuing additional 2064s (now a 44-year bond) at just above 1% interest rates—below core inflation trends—appears to be an excellent opportunity to lock in low long-term rates and help diversify the maturity calendar further.