Capital Debt Market Update - Fall 2021
You ain’t seen nothing yet
It has been a strange end to the 3rd quarter of 2021. Supply chain issues are not yet resolved entirely, the potential bankruptcy of property companies in China coupled with an energy crisis both there and in the UK as fall sets in will have impact on our North American markets. The anticipation of the announcement by the Bank of Canada to halt the quantitative easing strategy, played major havoc with GOC Bond rates resulting in the cost of investment capital to rise by over 50bps. The election of the Liberals in the fall amid a “green policy” that is grounded in anything other than strengthening the Canadian economy will definitely impact the Western Provinces, though the movement of population to what is perceived to be a less costly place to live with adequate opportunities for employment, should benefit Alberta.
One of the key considerations for investors and Avison Young’s Debt Capital and Advisory team is to find that sweet spot during the volatility of Bond Rate swings, where we can realize the best interest rates possible. While we have moved dramatically from the low point in late 2020 to early 2021 when the 5 Year GOC traded below 40bps, looking back over the last 5 years some interesting trends can be analyzed and provides some direction given current circumstances.
- In 2016 the year started with the 5 year at a range between 70 bps to 50 bps. Towards the end of the year the 5 year was trading above 100 bps and peaked at 120 bps. There was a premium for 10 year bonds, moving between 6 bps to 60 bps.
- By 2017 the 5 year moved up to 150 bps by July and peaked at 180 bps by the fall and winter. The premium for 10 year bonds was 3bps to 10 bps.
- 2018 began a period where 5 year bonds traded above 200 bps, with the range to mid-year being 190 bps to 220 bps. By the end of that year the 5 year had increased to 250 bps. 10 year bonds were being price at a differential of 5 bps to 20 bps, though there were points where the difference was negligible.
- Being the last year where the impacts of Covid were not at play, 2019 saw the 5 year bond decline below 200 bps at the start, dropping to 140 bps by mid-year, rebounding to 170 bps by years end. The variance between 5 and 10 year bonds ranged between 5 bps to 10 bps, though as in 2018 there were short periods where the variance was again negligible.
- 2020 started off with the 5 year declining to 160 bps and by mid-March had been within the 50 bps to 75 bps range. The variance in 5 and 10 year bonds started to expand to 15 bps mid-year, increasing above 20 bps and maxing out at 30 bps by years end.
2021 began the year with an unprecedented pricing model for 5 and 10 year GOC’s in the 40 bps to 60 bps range with the premium for 10 year bonds being between 40 bps to 60 bps. A spike occurred in the Spring which increased the 5 year to an excess of 100 bps with the premium for longer bonds trending downward. As we entered the fall the 5 year moved into a trading range of 120 bps to 150 bps. At the same time the variance reduced to 20 bps.
The impact of the alteration in BOC bond purchasing strategy was anticipated prior to the October Rate Announcement placing upward pressure on yields. Once the direction and commentary became public knowledge, downward trends became evident. Saying that, the volatility evidenced over the past 6 months will continue into 2022. The next Rate Announcement is scheduled for December 8th.
There may be greater likelihood of rate increases in the 1st Quarter of 2022, as the impact of inflation remains a concern. Our developer clients are seeing continued price increases across most material suppliers, limited availability of product and labour shortages are creating lengthier development time frames and difficulty in maintaining budgets. Canada’s inflation numbers attained a high of 4.4% in September which was the highest figure since 2003. Through the remaining part of the year the figure should settle around 4.75%.
As mentioned, the gap between short and longer term bonds are shortening. Where available, the ability to lock into current rates still presents an advantage when contrasted to the last 5 years. Generally, investors will require a higher yield the longer the maturity period. As we see the spread compressing, consensus could be that interest rates could be anticipated to fall again as economies begin to stabilize and seek a path out of the past 2 years. The existing curve, which had been baking in upward pressure on interest rates, is flattening quicker than normal ahead of an actual rate hike.