What does an increase in long-term government debt issuance mean for pension plans?
BY Yaelle Gang | August 5, 2020
As part of the federal government’s debt management strategy, it’s increasing long-term debt issuance.
In particular, the government will be increasing issuance of the 10-year and 30-year bonds for 2020-2021 to an unprecedented combined amount of $106 billion, according to the federal economic and fiscal snapshot from July 8. The issuance is roughly five times the previous years’ issuance of 10-year bonds and seven times for 30-year bonds.
“The government is taking advantage of the robust market demand for government of Canada bonds to ensure that much of Canada’s outstanding debt is less vulnerable to interest rate increases, which will maintain Canada’s debt sustainability for generations to come, securing a stronger economic future for all Canadians,” the snapshot report said.
From a government standpoint, it makes sense to term out some of the debt to take advantage of low rates, says Catherine Heath, vice-president and portfolio manager at Leith Wheeler Investment Counsel Ltd. “It makes the federal debt a lot less susceptible to increases in yields, so they’re not having to roll over the debt at potentially higher rates in say three to five years.”
On July 8, the 30-year bond market saw a sizeable sell-off of almost 10 basis points, she says. “But since then, [yields have] come right back [down]. In fact, we’re lower in yield today than we were on the announcement. There was sort of a knee-jerk reaction, but that didn’t persist.”
Today, yields on 30-year bonds are sitting at an all-time low of less than one per cent. “It just goes to show you that . . . supply is not a concern to the market,” says Heath. “The initial reaction was that it would be a bit of an issue. And we even saw that with concerns about crowding out of provincial bonds. Ontario bonds widened two basis points on the day of the announcement of Canada bond supply. But overall, . . . the reaction is pretty small considering.”
From a defined benefit pension plan sponsor’s perspective, it’s positive the government is increasing long-term issuance because DB plans are matching longer liabilities with long-term government bonds and supply is generally low in the long government-debt space. “To the extent that there’s supply available to match those long pension payments, this is actually a positive thing, unless of course there’s too much supply and then it starts to impact the valuation of those long-term bonds,” Heath adds. “But I think the government’s going to be very careful about ensuring that they don’t cause any kind of market disruption with this long-term issuance.”
Overall, 30-year bonds at below one per cent yield shows poor expectations for long-term inflation and growth, which is negative for any asset market, she notes. “If we’re going to be in a low-growth, low-inflation environment, the biggest implication for pension plans would be, what does that mean for the expectations for other asset classes? Not just fixed income, but what do your equity market returns look like in that type of environment? And even on the [alternatives] side?”
In this environment, Heath says she’s seeing quite a few plan sponsor clients shifting some fixed income assets into infrastructure and some are reducing the duration of their fixed income portfolios.
“But typically, we don’t see that when there’s a defined benefit pension plan where they’ve got specific long-term liabilities that have that mismatch. It’s just quite risky. And considering much of the world is in negative yield territory, it is possible that we see rates drop even further from here, even at these low levels. I’m seeing a lot of caution on behalf of clients where, if they have long-term liabilities, they’re wanting to match those off as closely as possible.”