When the stimulus stops: Economic danger points to watch for when the ‘punchbowl’ is pulled away
COVID support will end — and when it does it could create a whole new set of problems for borrowers, investors and governments
When the COVID-19 pandemic struck, the federal government and the Bank of Canada responded with a broadside of support programs and monetary stimulus. People and businesses received benefit payments and interest-free loans, while financial markets got rock-bottom interest rates and a massive bond-buying program.
The dollar amount of assistance has been huge. For example, the Parliamentary Budget Officer recently reported that the federal government will provide an estimated $122 billion in labour-market support for people in its 2020-2021 fiscal year, with roughly $42.8 billion more to come the following year.
Yet the emergency measures were not intended to be permanent, and while the pandemic isn’t over, it is being beaten back by widespread vaccination programs, improving the economic outlook. The federal government and the country’s central bank are now facing increased concerns about debt and inflation, among other things. Speculation has already kicked up around the Bank of Canada tapering its bond purchases, while the government may find itself under growing pressure to curb its spending.
However, removing support and stimulus measures could create a whole new set of problems for borrowers, investors and governments, who have been living with them for about a year now. Here’s a look at some of those concerns.
Governments
Public-sector borrowing costs have been held down during the pandemic by the Bank of Canada, which is not only snapping up federal government debt, but that of the provinces as well. The yield on the Government of Canada’s benchmark 10-year bond went from around 1.3 per cent in February 2020 to around 0.5 per cent by last summer.
However, while the Bank of Canada is still buying $4 billion a week in Government of Canada bonds via its quantitative-easing program — purchases it says it will continue to make until the economic recovery is well underway — markets are already looking past its promises.
“We see the Canadian economy returning to full capacity in 2022, sooner than the central bank has assumed,” Royal Bank of Canada economist Josh Nye wrote last week. “That leaves us expecting a rate hike in the second half of 2022 which markets are currently pricing in. Well before that first rate hike, we think the BoC will taper its QE program in April.”
The federal government is feeling these expectations, as its 10-year bond yield recently soared past 1.5 per cent on similar sentiments.
The BoC is also due to end its provincial bond purchase program in May, having bought more than $15 billion in those securities thus far.
A recent report from the International Organization of Securities Commissions (IOSCO), a global policy forum for watchdogs such as the Ontario Securities Commission, looked at the effects of government support measures on credit ratings and found cause for concern as well.
In particular, credit-rating agencies “noted that a more pronounced and longer period of fiscal loosening due to the failure to withdraw GSMs (government support measures) could have a negative impact on a sovereign rating due to persistent budget and debt deterioration expectations,” the report said.
A post-COVID-19 future for Canadian governments could include higher interest payments.
“Governments are only maturing a portion of their debt every year,” said Pedro Antunes, chief economist at the Conference Board of Canada. “And so the total debt financing costs don’t change as much, but eventually they will be ticking up as you’re rolling over new debt in these higher yields.”