While it’s never a good thing for a country’s credit to get downgraded to junk status, Portugal’s woes are positive news for Canadian bond holders.
Sal Guatieri, vice-president and senior economist at BMO, says when bad news happens to economies around the world—like Moody’s downgrading Portugal’s credit rating on July 5—investors scoop up safe products such as government bonds. People usually buy U.S. treasuries, but Canada sees an influx of fixed income investors too.
Canada’s 10-year government bond yields fell by four basis points on July 6. While that’s not great for people who want to buy bonds, it means that for current fixed income holders, their bond prices have gone up.
Also, it keeps the Bank of Canada from raising interest rates, which, depending on your perspective, can be positive. That’s good for variable rate mortgages or new homeowners gearing up to lock into a fixed rate.
Guatieri also points out economic uncertainty pushes the U.S. dollar up and the Canadian dollar down, and that’s a good thing, he says, because it improves the Canada-U.S. trade balance.
Where it’s not great is if you’re an equity investor, though TSX has closed in the black for five consecutive days. Still, the more uncertainty in Europe, the more investors consider selling stocks and buying bonds.
It’s unlikely Portugal’s downgrade will do any damage to Canadian markets, but that probably won’t be the case if Spain’s credit rating takes a beating. It may not happen—Spain’s government is stronger than Greece’s or Portugal’s and it has a better debt-to-GDP ratio—but it has a skyrocketing unemployment rate, which makes economists and investors nervous.
If Spain—a much larger and more important European country than Greece, Ireland or Portugal—does get downgraded one day, it could have a devastating effect on the markets.
“Fears of a contagion would really be magnified versus what we’ve seen at this point,” says Bob Gorman, TD Bank’s chief portfolio strategist. “That worries the equity markets because more difficulty in the European economies could translate into a double dip recession.”
For now though, enjoy the higher bond prices and low interest rates. “As long as the crisis can be contained and limited to, say, Greece,” says Guatieri, “this could support our economy.”