The AAA Credit-Rating Club is Getting Cozy and Canada Stands to Benefit from it

logo-cropped-11Silver lining in flat interest rate environment. Canada is part of an exclusive, shrinking club of top tier sovereigns.

Source: Financial Post

The number of countries with a pristine AAA credit rating is shrinking and fund managers say Canada stands to benefit from being in the ever-more exclusive club.

Both Fitch and Standard & Poor’s downgraded the United Kingdom in the wake of the Brexit vote, bringing the club’s membership to 12. On Monday, S&P warned that its ranks could shrink even further: The rating agency placed Australia on watch following incredibly close election results that threaten political gridlock in that country.

All the global volatility means that Canadian bonds have been performing strongly in the past couple of weeks, seen as relatively insulated from a more unstable world.

“Throughout the most recent turmoil, the Canadian corporate credit market was operating very well and had a bit of a safe haven status,” said Andrew Torres, founding partner and chief executive of Lawrence Park Asset management. “It was a little detached from the turmoil in Europe and we noticed trading a rough mix of Canadian, U.S. and European corporate paper that Canada has been a lot more stable while we’ve seen this global market volatility.”

The AAA rating is assigned by credit ratings agencies to countries seen as the most stable politically, economically and financially. The current list of countries given that rating by all the major agencies includes Australia, Canada, Denmark, Germany, Hong Kong, Liechtenstein, Luxembourg, Netherlands, Norway, Singapore, Sweden and Switzerland. Of the group, only Germany has an economy that is larger than Canada’s.

Not only has the AAA-rated club become more exclusive in recent years, it has also lost members with some of the largest and most liquid bond markets. S&P downgraded the U.S. in 2011 following a bitter dispute in Congress about raising the debt ceiling (the first ever downgrade for the country from AAA).

With a lack of large, liquid countries such as the U.S. and U.K. now in the AAA list, the countries with relatively large bond markets in the club stand to benefit more than others, say economists Derek Holt and Dov Zigler of Scotiabank.

“Among bond markets of any reasonable size and liquidity, the ‘AAA’ list is yet more exclusive with markets like Germany and Canada among the leaders,” the pair wrote in a note to clients.

It may be a long road, however, for Canada to join the ranks of the world’s safe haven markets, such as the United States and Japan. While both countries have lost their AAA ratings, they, along with countries such as Switzerland and Germany, are still seen as go-to safe havens when volatility spikes in the global market place. Few investments are seen as being as safe as U.S. Treasury notes.

The desire for Treasuries show that investors are willing to discard ratings if an asset has a history of riding out volatility. As well, investors in Canada are still more sensitive to the performance of the dollar and the country’s large exposure to energy, something which plays an important role in whether investors decide to park cash here.

“When you get a flight to safety — when the world becomes a little more uncertain — investors tend to gravitate to the largest and the most liquid markets,” said Darcy Briggs, portfolio manager at Franklin Bissett Investment Management.

But Briggs says that the AAA rating will continue to help Canada attract capital. While there are future risks to the rating — the government is currently undertaking an expensive stimulus program dependent on borrowing — there are few signs on the horizon that the country will be stripped of its vaunted title. That should continue to keep a shine on Canadian bonds.

“Canada will benefit from some of that coming our way, because of the rating,” he said.