March 17, 2016 / 6:13 PM / a year ago

Ample demand seen for Canada govt's increased bond issuance

TORONTO, March 17 (Reuters) - A ramping up in Canadian government bond sales to finance deficit spending will be met by ample demand, say market players, who predict recent underperformance by the country's long-term bonds against U.S. Treasuries is set to reverse.

Canada's new Liberal government will introduce its first budget March 22 and is expected to run a C$29 billion ($22 billion) deficit in fiscal 2016-17, a Reuters poll showed, as it borrows more to increase infrastructure spending in the hopes of boosting growth..

Typically, an increase in supply of a country's bonds triggers higher yields. But fixed-income investors note global hunger for yield has intensified after many central banks went sub-zero with interest rates.

"We are seeing tremendous demand from insurance companies and pension funds for long-duration assets," said Ed Devlin, head of the Canadian portfolio management team at Pacific Investment Management Co (PIMCO), which has C$26.1 billion in assets under management for Canadian clients, according to its website.

With Canadian rates "incredibly low" and the yield curve relatively flat, the timing is right from an issuer's perspective, he added.

Bond issuance for the fiscal year may rise by nearly one-third to C$120 billion, according to a research report last week from Andrew Kelvin, senior rates strategist at TD Securities.

"There's a shortage of high quality collateral out there," said Mark Wisniewski, senior portfolio manager at Sprott Asset Management. "Fiscal policy makes so much more sense."

To be sure, an expected increase in supply may have contributed to recent underperformance by Canadian long-term bonds against Treasuries.

The yield on Canada's 30-year benchmark bond, which was 88 basis points lower than its U.S. counterpart in December, is now just 62 basis points lower. The spread in December was the widest since 2011.

However, part of the underperformance can be attributed to a less-dovish Bank of Canada and shifting inflation expectations, market players said.

PIMCO's Devlin expects Canadian bonds to outperform by the end of the year as the market becomes less sanguine about Federal Reserve rate hikes and the Bank of Canada stays on hold.

At TD Securities, the jump in supply is expected to be accommodated in part by larger auction sizes, together with extra 10- and 30-year auctions.

Low federal debt leaves the government in a good position to be "expanding issuance," said Kelvin.

($1 = 1.3003 Canadian dollars)

Reporting by Fergal Smith; Editing by Dan Grebler

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