January 19, 2016 / 7:49 PM / 2 years ago

UPDATE 1-Record-low Canadian yields seen hurting C$, pensions, aiding gov't

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By Fergal Smith and Matt Scuffham

TORONTO, Jan 19 (Reuters) - A plunge in Canadian bond yields to record lows is seen further undermining the country’s struggling currency and increasing the funding challenges for its pension plans, even as it offers welcome savings to cash-strapped governments.

Canada’s 10-year government bond yield touched an all-time low of 1.143 percent on Monday, well below the yield of more than 2 percent for its U.S. counterpart, as a drop in oil to its lowest price since 2003 darkened the country’s economic outlook.

Oil’s move also knocked the Canadian dollar to a 12-year low on Monday. Traders have increased bets in recent sessions that the Bank of Canada will cut interest rates on Wednesday to support the economy, a prospect that has driven bond prices higher.

Analysts said the resulting lower yields add to downside risks for the Canadian dollar by reducing the allure of Canadian assets for foreign investors.

“Relative to the U.S. and some other countries we’re offering less attractive returns and that just puts downward pressure on our currency,” said Sal Guatieri, senior economist at BMO Capital Markets.

Low government bond yields also make it harder for Canadian pension funds to meet their long-term obligations to the country’s aging population, raising concerns some plans could experience shortfalls.

“Various jurisdictions in Canada have provided temporary funding relief to defined benefit pension funds in recognition of the stressed environment,” said David Zanutto, Canadian Director of Strategic Research at consultancy Mercer.

“If this relief ends and low rates persist, a number of plan sponsors could face significant difficulty.”

Canada’s 10 biggest pension plans, which manage over C$1 trillion of assets, have been moving funds out of fixed income securities into riskier asset classes such as infrastructure and real estate. However, some say those markets are in danger of becoming overheated.

The big winner from the bond yield trends remains government. Canada’s debt service charges as a percentage of revenue had already hit a record low 9.4 percent, according to government data. And the government’s most recent fiscal update in November assumed a 2.5 percent 10-year bond rate for 2016, more than twice the current level.

The federal and provincial governments “are locking in some pretty attractive long-term rates,” said Darcy Briggs, a fixed-income portfolio manager with the Bissett unit of Franklin Templeton Investments.

Still, the declining yield environment reflects a deteriorating economic climate which will hit government revenue. Some analysts say this adds to the case for more stimulus spending.

Canada’s Liberal government won last October’s federal elections on the back of a promise to run C$10 billion deficits to help offset the oil price shock. Sources familiar with the party’s plans have said they now look certain to run even higher deficits.

Editing by Jeffrey Hodgson and Alan Crosby

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