April 2022: Canadian Monthly Corporate Bond Watch

PM spotlight

Randall Malcolm, MSc, CFA, Senior Managing Director & Portfolio Manager, Public Fixed Income

After its worst quarterly performance in over 40 years in the first quarter of 2022, the Canadian bond market continued its downward trend in April. The FTSE Canada Universe Bond Index was down another 3.49% in April as both interest rates and credit spreads increased. Over the month, the 2-year Government of Canada bond yield rose 36 bps while the 30-year Government of Canada bond yield increased by 44 bps.

Corporate and provincial credit spreads moved wider during the month. On aggregate, corporate credit spreads increased by roughly 15 bps across the maturity spectrum. In this risk-off environment, telcos (higher beta, BBB-rated) and financials (often deemed the most liquid corporate bonds) credit underperformed as investors were taking risk off the table. With market volatility still elevated, new issuance was slow in April with a approximately half of the typical volume. The increase in provincial spreads was more muted and, generally speaking, the latest provincial budgets and financial updates surprised on the upside.

Canada’s year over year increase in CPI was 6.7% in March, reaching a new three-decade high and exceeding market expectations. On April 13, the Bank of Canada hiked the benchmark interest rate by 50 basis points in an effort to control inflation. This marked the first time the Bank of Canada has raised rates by more than 25 basis points in over two decades.

U.S./Canada relative value remained attractive at the end of April, with both the US/CA swap and spreads differences little changed on a month-over-month basis.

 

Mar. 31

Apr. 29

Change

U.S./CA swap difference

56 bps

53 bps

-3 bps

U.S./CA OAS difference

-28 bps

-27 bps

1 bps

U.S./CA relative value

28 bps

26 bps

-2 bps

Credit spreads by quality and maturity (bps)

Corporate and provincial spreads increased on a month-over-month basis.

Annuity proxy and related market spreads (%)

We expect an increase in the annuity proxy from 1.40% to 1.50% (our estimate of the unrounded annuity proxy is 1.53%) based on the current levels of credit spreads and the current shape of the risk free curve. The actual annuity proxy will also reflect changes based on annuity market competition, asset availability and changing longevity views, and will differ from this hypothetical estimate.

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The content of this presentation is intended for institutional investors only. It is not for retail use or distribution to individual investors. All investments involve risk including the possible loss of capital. This presentation is for informational and educational purposes only. Past performance is not a guarantee of future results.

Unless otherwise stated, all figures and estimates provided have been sourced from Bloomberg and SLC Management internal credit research. The information provided on issuance is based on internal experience internally. Unless otherwise noted, all references to “$” are in CAD. Any reference to a specific asset does not constitute a recommendation to buy, sell or hold or directly invest in it. It should not be assumed that the recommendations made in the future will be profitable or will equal the results of the assets discussed in this document.

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Credit spreads by quality and maturity (graph)

Option adjusted spreads of the securities included in the FTSE Canada Universe Bond Index for different maturity buckets. Quality breakdown based on DBRS ratings. “FTSE®” is a trade mark of FTSE® International Limited and is used under license.

Annuity proxy and related market spreads: (graph)

The Annuity Proxy (Actual) references the appropriate spread to be added to the Government of Canada marketable bonds, average yield series, over 10 years (CANSIM V39062) as a proxy for the annuity purchase yield for a medium duration pension plan, as published in Canadian Institute of Actuaries (“CIA”)’s educational notes on “Assumptions for Hypothetical Wind-Up and Solvency Valuations” at various effective dates (“CIA’s educational notes”). Corporate and provincial spreads are the duration neutral (relative to the liabilities) option adjusted spreads based on a blend of mid and long term FTSE Canada corporate and provincial indices. The Annuity Proxy (Hypothetical) is based on an internal SLC Management auto regression model that seeks to explain the historical “Average of the Three Most Competitive Hypothetical Quotes” (“hypothetical quotes”) as published in the CIA’s educational notes, using FTSE Canada provincial and corporate spreads, and changes in the shape of the Government of Canada risk free yield curve as explanatory variables. According to the CIA’s educational notes, these hypothetical quotes are given weight by the CIA in determining the annuity proxy guidance, in addition to data collected on actual annuity purchases and bona fide quotations. For greater certainty, the actual and bona fide quotations used by the CIA are not publicly available and have not been considered in our determination of the Annuity Proxy (Hypothetical).

Hypothetical performance data does not represent the performance of actual client portfolios. Trading and other costs have not been deducted from the performance data (e.g. commissions and custodial fees). Hypothetical results may differ significantly from actual performance, as there may be variations in the percentage of each security held, the timing of security purchases and sales, and the availability and/or price of a particular security over time as the portfolio does not reflect actual market conditions. Forward-looking statements are speculative in nature and may be subject to risks, uncertainties and assumptions and actual results which could differ significantly from the statements. Do not place undue reliance upon such forward-looking statements.

Forward-looking statements are speculative in nature and may be subject to risks, uncertainties and assumptions and actual results which could differ significantly from the statements. Do not place undue reliance upon such forward-looking statements.

U.S./CA relative value (table)

U.S./CA swap difference is the weighted-average pickup that results from the cross currency swap based on the key rate durations of the Bloomberg Barclays US Long Corporate Index. US/CA OAS difference is the difference between the option adjusted spread of the Bloomberg Barclays US Long Corporate Index and the Bloomberg Barclays Canadian Long Corporate Index.

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