Out of Darkness Comes Light



The COVID-19 pandemic has been indeed the top story so far in 2020, but the oil price war between Saudi Arabia and Russia has also had a substantial impact on financial markets. Together, they’ve derailed the demand/supply equilibrium and driven oil prices down to levels never seen before – a dark backdrop for Canadian producers, who were already struggling with pipeline and transportation issues. Oil-producing provinces have also suffered, and Alberta, Saskatchewan and Newfoundland’s bond spreads have widened significantly as a result. As they did during the 2015 crash in crude prices, investors are pricing in higher budget deficits due to lower royalty revenue. Albertan bond spreads over comparable Ontario bonds went from went from -10 bps to +20 bps as the price of Western Canadian Select crude fell from $50 in May 2015 to $15 in February 2016. That same spread widened by more than 40 bps in March 2020 alone.



But here’s the light. The provincial bond purchasing program announced by the Bank of Canada a month ago will begin mid-May and will entail up to $50 B of provincial bond purchases in the primary and secondary markets, providing liquidity and helping provinces finance their budget deficits. This program will be allocated to each province based on their GDP, a measure on which Alberta ranks third in the country – the benefits won’t be as significant for Saskatchewan and Newfoundland, which have much smaller economies. Following the announcement, spreads between Alberta and Ontario bonds tightened about 20 bps, and we wouldn’t be surprised to see this trend continue, as Alberta is still, by far, the province with the lowest debt.

When these kind of market dislocations arise and investors are blinded by darkness, we prefer to build a position as the crisis evolves, and wait for the market to see the light.

 Jean-Guy Mérette

Vice President and Portfolio Manager
Active and Strategic Fixed Income Team