Nafta or Not, Pimco Is ‘Playing Defense’ in Canada Amid Growing Risks

(Bloomberg) -- Higher interest rates, lackluster growth and inflation risk mean it’s time for Canadian fixed-income investors to play it safe by sticking to shorter-term bonds and defensive assets, a trio of portfolio managers told a Bloomberg conference.

“We’d be a little skeptical of getting 2 percent growth numbers this year and the year after,” Ed Devlin, managing director of Pacific Investment Management Co., told the Bloomberg Canadian Fixed Income Conference Tuesday in New York. He added that growth could miss that target by a few basis points.

“We’re playing defense now to play offense later,” Devlin said.

Devlin recommended buying two- to five-year bonds along with defensive sectors like provincial debt, banks and autos. He also thinks inflation-linked bonds in Canada are attractively priced, and is avoiding consumer-oriented securities like credit cards and non-insured mortgages.

The Canadian economy has been too reliant on consumers and real estate, with 93 percent of economic growth since the financial crisis coming from those two sectors, he said. More business investment is necessary to keep the economy healthy, but Devlin expressed doubt that the transition will go smoothly.

“Canada has been a one-trick pony,” he said “We’ve been riding that pony too long, we’ve got to jump off and give it some water.”

‘Stagflation Light’

With slowing growth and higher inflation, the country could be facing “stagflation light,” said Romas Budd, vice president and head of fixed income at 1832 Asset Management, a division of Bank of Nova Scotia.

“Central bankers, including the Bank of Canada, are downplaying inflation risk,” he said.

While nothing in Canada’s fixed-income market looks particularly attractive right now, corporate leverage is more of a concern than inflation, said Dagmara Fijalkowski, head of global fixed income and currencies at RBC Global Asset Management.

“We’re getting particularly choosy” with our investments, she said.

The new trilateral trade pact among Canada, the U.S. and Mexico has removed some risk from Canada’s economy but it’s not ratified yet, Devlin cautioned.

“I’d say it’s more likely than not, but I’d still say there’s a fair bit of risk that it could get pushed given the partisan politics in the United States,” he said.

Major Risks

Earlier in the day, economists from three of Canada’s largest financial institutions said the country’s economy faces a major risk from debt-laden consumers and rising rates. Past 2020, “it’s really going to hit the fan,” said Beata Caranci, chief economist at Toronto-Dominion Bank. “At that point you have high levels of indebtedness combined with income stress happening simultaneously.”

The risks around consumer finances will lead the Bank of Canada to remain cautious about raising interest rates, said Stefane Marion, chief economist at National Bank of Canada. The central bank will re-assess its path after moving the policy rate to 2 percent, he said, adding that will help avoid a consumer-led downturn.

“I don’t see an accident waiting to happen in the housing sector,” Marion said.

The country’s housing agency has enough of a cushion. The Canada Mortgage and Housing Corp. has sufficient capital to withstand “severe scenarios” such as a financial system crisis or a major slump in oil prices, Romy Bowers, chief commercial officer of CMHC, told the conference.

U.S. Deals

Two of Canada’s biggest pension plans meanwhile are looking to the U.S. bond market to expand their borrowing programs, with Public Sector Pension Investment Board planning its first bond sale south of the border.

PSP is planning an inaugural benchmark-size deal of about $1 billion in the U.S. market as part of a new global borrowing program, Treasurer Renaud de Jaham said. Caisse de dépôt et placement du Québec aims to return to the U.S. market for the first time since 2014 to begin building out a yield curve next year, said Yassir Berbiche, vice president treasury.

Caisse, which invests on behalf of Quebec retirees, sees the fund needing about $20 billion U.S. equivalent in funding over the next four to five years, Berbiche said. They’re aiming to build a two- to 10-year yield curve, returning to issue once a year, he said. Caisse would also consider issuing green bonds in the next few years, Berbiche said.

PSP, which manages the retirement savings of workers including the Royal Canadian Mounted Police, is looking to attract a diverse investor base and anticipates assets under management doubling to C$300 billion ($233 billion), requiring C$25 to C$30 billion of issuance, de Jaham said.

--With assistance from Jacqueline Thorpe, Allison McNeely and Esteban Duarte.

To contact the reporters on this story: Kristine Owram in Toronto at kowram@bloomberg.net;Paula Sambo in Sao Paulo at psambo@bloomberg.net

To contact the editors responsible for this story: Courtney Dentch at cdentch1@bloomberg.net, Carlos Caminada, David Scanlan

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