Canada – Page 38

Canada ends the fiscal year with $47 billion deficit

The 2009-2010 year-end fiscal monitor is finally released. I will make some year-to-year comparisons.

From April 1, 2008 to March 31, 2009 the government posted a $2.2 billion deficit. In 2009-2010, the government posted a $47.0 billion deficit.

Revenues were down about 5% year-to-year, mainly attributable to a decrease in personal income tax and corporate income tax collections. The corporate side would have been a lot worse if it wasn’t for a huge recovery in the later part of the 2010 fiscal year.

The one interesting item is that the proxy for general consumption in the country, the Goods and Services tax, had a decrease of 0.2% year-to-year in revenues, so this is virtually unchanged. Similar to corporate income taxes, there was a huge surge in collections in the last part of the fiscal year.

On the expense side, government expenses were up approximately 17%. The bulk of this is attributable to the “economic action plan”, i.e. the stimulus package. The stimulus package, as projected in the 2009 budget, was approximately $23 billion, so one can infer that if it weren’t for the stimulus, the deficit would have been around $24 billion – a fairly manageable number.

Most notable is the 35% increase in Employment Insurance premium payments – mainly a function of increased unemployment, but also factored into this were government legislative efforts to enhance EI benefits for those that paid into the EI program for a lengthy period of time (7 years or over) receiving an extended amount of benefits.

My quick guess for 2010-2011 is that we will continue to see significant growth in revenues from the three main sources – personal income tax, corporate tax and GST collections in the 2010-2011 fiscal year. On the spending side, we will continue to see spending as well, and probably see a posted deficit of around $35-40 billion. This cannot continue indefinitely, otherwise Canada might face its own entitlement crisis. Although relative to other countries we are in better shape, we should be returning our fiscal balance to a mild surplus position and save some capital for future rainy days – which is more than likely to occur for the duration of this decade and beyond as the baby boomer generation retires.

Canadian Interest Rate Predictions

The last three weeks of market volatility have had a profound effect in driving demand for risk-free, liquid government investments. The Bank of Canada has been a recipient of some of this inflow, as demonstrated by the 5-year benchmark government bond rate:

Speculators would have made a fairly good gain had they bought around 3.1% and sold today at around 2.6%. Of course, the best trades are done in retrospect, so this is just like saying that I could have picked the last 6 digits of the lottery and won a million dollars. Whether the yield will go lower or not remains to be seen.

What this does mean, however, is that 5-year fixed rate mortgages are likely to drop from their existing levels of around 4.54% (at ING Direct) or 4.39% (a typical mortgage broker) to something down 25 basis points or so. I would expect the 5-year rate to be around 4.25% for most retail customers. I generally ignore the posted bank rates since they are always inflated and when negotiating, they usually have a standard rate that is a good percent and a bit below those rates. Competition has whittled that process down to a formality of just asking, but I am sure there are some financially uninformed people that believe the posted rate is the only one they can get.

The Bank of Canada will be raising the target (short term) rate on June 1. This is inevitable, but the question is whether they will be raising 50 basis points or 75 basis points. Right now the 3-month banker’s acceptance futures (the only short term interest futures instrument actively trading in Canada) is implying a June rate of 0.81%.

My prediction is that the Bank of Canada, on June 1st, will raise the overnight target rate 0.5% to 0.75%.

Since this is mostly baked into the markets, the effect this will have on longer-term rates is nil. However, for those that are on variable rate mortgages, they will be paying 0.5% more since the prime rate will go up a corresponding amount. On a $300,000 mortgage, this would mean $1,500/year in payments or about $125/month additional.

My projection for the end of December will be 1.5%, down from 1.75% as projected a month earlier. My prediction is that rates will go up another 0.25% on July 20, 0.25% on September 8, no change on October 19 and up 0.25% on December 7.

Canadian Interest Rate Projections – May 2010

I figure it would be helpful to see what the Canadian interest rate futures are doing and to make some projections as to what the market is saying about future rate increases:

Month / Strike	Bid Price	Ask Price	Settl. Price	Net Change	Vol.
+ 10 MA	0.000	0.000	99.375	0.000	0
+ 10 JN	99.150	99.160	99.250	-0.100	14740
+ 10 JL	0.000	0.000	99.365	0.000	0
+ 10 SE	98.730	98.740	98.820	-0.080	22075
+ 10 DE	98.340	98.350	98.410	-0.060	29381
+ 11 MR	98.050	98.060	98.100	-0.050	8873
+ 11 JN	97.740	97.770	97.810	-0.060	2777
+ 11 SE	97.440	97.480	97.550	-0.080	2076
+ 11 DE	97.220	97.270	97.310	-0.070	216
+ 12 MR	96.910	97.150	97.060	-0.250	1
+ 12 JN	96.550	96.930	96.860	0.000	0

My projection for the Bank of Canada overnight interest rate level is the following:

June 1, 2010 (+0.50% to 0.75%)
July 20, 2010 (+0.25% to 1.00%)
September 8, 2010 (+0.25% to 1.25%)
October 19, 2010 (+0.25% to 1.50%)
December 7, 2010 (+0.25% to 1.75%)

What has changed since my last projection is that the initial rate increase in June 1, 2010 will be 0.50% instead of 0.75%. I still see subsequent rate increases of 0.25% at each scheduled announcement. You can probably thank the European debt situation for this change.

Although Canada’s economy is much less linked to Europe than it is to the USA, it is enough to factor into the economic calculation. In particular, the Euro has dropped significantly and this will lessen the competitiveness of Canadian exports into the Euro market.

That said, relative to the US dollar, the Canadian dollar has slipped a little, but this probably isn’t enough to take into consideration other than “wait and see”.

Long-term rate projections, which is more relevant for mortgage pricing, has had rates drop over the past two weeks. 5-year bond rates are 2.74%, while the 10-year is at 3.47%, which is roughly the rates seen in the past three quarters. If the market stabilizes at the existing level, I would not be shocked to see a 5-year fixed mortgage rate offered at 4.00% in the next couple weeks.

A simple risk-free money procedure

This post is not to be taken seriously, but if you actually tried it, it would work.

Steps:

1. Have marginable assets (i.e. shares of widely held and liquid companies) in Interactive Brokers.
2. Withdraw cash from Interactive Brokers. For every $100 in shares you have, you will be able to borrow $70 in cash (using Canadian shares of widely held companies as an example, which allow for 30% margin). This obviously leaves zero room for a decline in equity price, so you would have to judge accordingly.
3. Observe margin rate. Currently 1.753% for the first $120,000 and 1.253% for the next $980,000.
4. Deposit cash proceeds into Ally, with a current interest rate of 2%. (Note: The risk here is that Ally would go belly-up, and CDIC only covers $100,000).
5. Whenever the margin spread goes to zero, close the transaction.
6. When it comes to tax time, remember to deduct the interest expense (margin) against the interest earned.

Assuming you had $142,857 in stocks in your account, you could conceivably pull out $100,000 cash and be able to earn an extra pre-tax $247/year, at current rates risk-free!

Obviously there is a limit to how this scales up, but you can easily see how the same procedure can apply to anything else with a higher yield. The risk you have to manage is the risk of losing principal on the investment (in this case you are investing in cash earning 2%, but in real-life scenarios people would typically invest in preferred shares or corporate debt or any other yield-bearing investment), liquidity risk (if another 9/11 happened and you were not able to sell your shares, you would be in trouble) and margin risk (making sure that you are not forced to liquidate the holdings).

Borrowing money at low rates and investing it in higher rate products is what banks and insurance companies typically do, but there is no reason why retail investors, assuming they know what they are doing, can’t get in the action as well.

Canadian Fiscal Monitor, February 2010

The government of Canada released its fiscal report for the 11 months ended February 2010, and we continue to see considerable improvement compared to last year’s results:

In the February 2009 vs. 2010 (one month) comparison:
1. Corporate income tax collections are up 31%;
2. GST collections are up 52%;
3. Other excise taxes and duties are up 22%;

Employment continues to be weak; EI payments are up 35% from the previous year. As EI benefits will only last one year, it is likely that during the same period in 2011 that this number will be lower as employment picks up.

The next month will have tentative results that I will make year-to-year comparisons with, in addition to seeing where the government was significantly off with its fiscal projections compared to the Budget 2009 document that was tabled in late January 2009.