The end of Canada’s quantitative easing strategy and higher than expected interest rates will be beneficial to Canadian defined benefit pension plans, according to Sebastien Betermier, an associate professor of finance at McGill University’s Desautels Faculty of Management.
On Wednesday, Tiff Macklem, governor of the Bank of Canada, announced plans to end its quantitative easing policy and replace it with a reinvestment plan. Unlike the quantitative easing policy, which saw the central bank buy as much as $5 billion of Canadian government bonds per week, the reinvestment policy will instead buy up only maturing bonds.
The decrease in demand for bonds is expected to push up yields. In the same press briefing, Macklem also announced that the bank’s predictions for inflation in 2022 increased by a full per cent — 2.4 per cent in July to 3.4 per cent in October.
The announcement is good news for Canadian institutional investors, says Betermeir. “Yields are lower than they have ever been. Combined with a rise in longevity, it is really difficult for pension funds to meet their liabilities. Higher yields can only be a good thing.”
While bond-heavy pension portfolios may see their value dip as bond prices fall, the economic situation will also result in lower liabilities for most pensions. “If you take a pension fund that has 50 or 60 per cent of its assets in bonds, it will go down in value,” he says. “But the liabilities will go down more.”
While Betermier is hesitant to make any firm predictions on whether bond yields will rise and remain higher in the long term, he believes they’re unlikely to reach the levels seen during the mid-1990s. “I am of the opinion that yields will generally remain lower than what they used to be for structural reasons in the economy. We’re still quite far away from the high yields of the mid-1990s. This is a short-term fluctuation in that sense.”
Another area of uncertainty relates to interest rates. While the Bank of Canada didn’t raise its rates in October, there’s a widespread expectation that Canada will see interest rates climb in the coming months as part of an effort to curb inflation.
“One of the big question marks is whether inflation will persist,” says Betermier. “There are reasons for it to hike after the pandemic. All of these may increase the risk of inflation being higher than two per cent. Supply shortages are taking longer to be fixed. The danger is that when you have high inflation expectations, it may become a self-fulfilling prophecy.”