Capital inflow continues

In November 2010 foreign investors continued their Canadian acquisition binge.  This was one of the first month (in 2010) where all three segment (Stock, bonds & money market) saw positive inflow.  Then again, Canada is the flavor of the month.  Inflation is (more or less) under control [CPI at 2.0% and core CPI at 1.4%], the currency is strong, the government seems to have a plan, and employment is rising. 

In fact, in US dollar terms, the Canadian stock market has outperform the U.S. markets in 8 of the past 9 years (the exception was 2007).  This out performance exceeds 500 bps each year – which is enormous.  Canadians realized this, and have been reducing their foreign equity holdings (a recurrent theme), and shifting towards government bonds.  On another note, as of this morning the gap between the yield on the US and Canadian Treasure bonds in the 10 and 30 years stands at -5bps and -88bps, levels never seen – a clear indication that not all AAA rated government bonds are viewed alike by investors.

Today (Tuesday January 18) the Bank of Canada will meet to decide what to do about short term interest rates; bottom line rates will remain unchanged.  The very strong demand for Canadian long dated bond adds complication to Canada’s monetary policy, since a flat yield curve creates limits to some of the BoC’s policy tools (but at least the BoC doesn’t have the U.S.’s zero bound problem). 

Today, Canada’s sovereign bond rates are as follows:

01/19/11	Rate
Overnight	1.00%
1 Year	1.44%
2 years	1.76%
5 years	2.33%
10 years	2.99%
30 years	3.68%

If this were America, the difference between short term interest rate and the long end of the curve 2.68% is remarkably small (the US curve is much steeper at 4.43%), an indication that inflation fears are mitigated (Canada’s equivalent to TIPS is pricing 1.24% tracking down from nearly 2% in 2008). 

Bottom line:

Foreigners continue investing in Canada, their perception that the economy is sutainable, where nearly half of its GDP is related to natural resources (metal, minerals, foodstuff and energy) that its governments appear to have "a plan" and that its financial system appears to be functioning.

A note:  Last week the Minnesota Federal Reserve announced that pressures on America's financial system were easing... Just before Christmas the Bank of Canada released its semi annual review of Canada's financial system, they found that stresses to the system were at higher levels, equal to what was faced in 2008...

Only one of these two can be right, my money is on the BoC