In its Fall Economic Statement 2022, released on November 3, the Government of Canada announced that it “has decided to cease issuance of real return bonds (RRBs) effective immediately.” The reason cited was low demand for RRBs. The move was a surprise to bond dealers, and is unprecedented among G7 countries with an inflation-linked bond market. Prior to the announcement, RRBs were expected to make up 0.5% ($1.4B) of GoC bonds issued in the current fiscal year, and 6% of 30-year GoC bonds issued[1]. For comparison, In Q2 2022, US TIPS made up 4% of US Treasury bonds issued, and 38% of 30-Year US Treasury bonds issued[2]. The next RRB auction was scheduled for December 1, 2022.

Real return bond markets froze after the announcement. We expect that over the next few days institutional investors, investment managers and index providers will have discussions on a path forward for their existing products and allocations. We suspect that total return investors may no longer wish to hold on to their RRBs as the asset class becomes increasingly illiquid, and this could result in some additional supply in the short to medium term. However, investors that hold real return bonds to back inflation-linked liabilities, such as pension plans and insurance companies, will likely hold their existing positions to maturity and may look to absorb any additional supply to satisfy any future planned RRB purchases.

Real return bonds have played an integral role in de-risking pension plans in Canada with benefits that contractually increase with inflation – either as an asset class directly purchased by those plans or purchased by insurance companies to back inflation-linked annuity purchases. This change may have an impact on any plans that wish to purchase inflation-linked annuities or increase their RRB allocation.

Plans with existing RRB allocations backing liabilities could consider holding these positions to maturity as they should continue to provide a good hedge to their liabilities. To supplement their inflation hedge going forward, plans may look to use U.S. Treasury inflation-protected securities (TIPS), U.S. inflation swaps or real assets, depending on their objectives and risk tolerances. In the absence of a real return bond market, some plans may purchase nominal bonds and attempt to offset unexpected increases in inflation through higher-yielding fixed income products such as corporate bonds or multi-asset credit strategies.

[1] Update on the 2022-23 Debt Management Strategy, Government of Canada
[2] Fiscal Year 2022 Q2 Report, U.S. Office of Debt Management

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