Canadian bonds weaken as equities rally; European debt crisis eyed; secondary market thin

By Rebecca Melvin

New York, Oct. 21 - Paper in both the Canadian investment-grade and high-yield corporate bond markets was well bid on Friday, but volumes were low and pricing was weak as has been the case for much of the past week. Investors are awaiting more clarity on the European sovereign debt situation, market sources said.

The driving force in all the financial markets is European events, and the focus is on next Wednesday, sources said.

In tandem with weaker bonds, equities surged as it looked more likely that European leaders will be able to hammer out a credible plan to protect the banking system. The announcement of a second summit meeting on Wednesday raised expectations of a positive outcome.

"Either it's going to be a credible plan that addresses the banking system, or it's not. If the plan is not credible, the bond markets will rally," a Toronto-based fixed-income strategist said.

Steady new supply

As for Canada's primary market in the past week, "there were a couple of issues in the IG market that were very successful. But really it's steady as she goes," a Toronto-based syndicate source said.

Successful high-grade issues included utility operating company CU Inc., which sold C$700 million of 30-year to 50-year debentures, and George Weston Ltd., which tapped the Canadian bond markets on Thursday in a well-subscribed C$350 million offering of five-year medium-term notes.

On Friday, Weston was about 15 basis points tighter than issue and CU was about 3 bps tighter than issue," according to the Toronto source.

A three-month lull in primary activity in high-yield issuance was broken this past week when restaurant operator Cara Operations Ltd. announced on Monday that it intends to sell C$75 million of senior second-lien guaranteed notes to finance the acquisition of Prime Restaurants Inc.

Also in Canada's high-yield market is GreenField Ethanol Inc.'s C$175 million of five-year senior second-lien notes.

Both of those deals are still in the consent phase and roadshows are upcoming, so they have not officially launched the deals.

"It's really early days on those. Neither one has presented to investors yet, so it's difficult to say how they will do," a syndicate source said.

Secondary active

Meanwhile, the high-yield secondary market was well bid Friday, with pricing dependent on the particular issue, a high-yield sales and trading specialist said.

"There have been good inflows. Of course, everyone would like the old prices, but no one is offering at the same levels. They are drifting higher, and with no redemptions, no one is a forced seller," the strategist said.

In the provincial bond market, three new deals priced in the primary in the past week, including the Province of Ontario's C$1 billion in a reopening of its 4.4% eight-year notes; Financement-Quebec's C$500 million add-on to its 3.5% six-year notes; and Bank of Montreal's C$450 million of one-year floating-rate notes.

Trading in the provincial secondary market Friday was little changed to 0.5 bp tighter, a strategist said.

Meanwhile volume remains low in the secondary market, provincial sources said.

Canadian government bonds were down, sending yields up across the curve in step with U.S. Treasuries. The 10-year note yield rose to 2.342%, up from 2.303%.

Government bonds lower

Canadian bonds sold off with the U.S. markets as global equity markets rallied.

"It's the hope or fear trade, and it's been hope for the last two weeks," a strategist said.

The general trend in equities has been up, while that of bond markets has been lower, given expectations that Europe will be able to tackle its debt crisis successfully and avert another Lehman Brothers-type event, the strategist said.

In 2008, Lehman Brothers declared bankruptcy and global financial markets seized up as a result.

"Equities are hoping that Europe can ring fence and protect the banks, and then we won't have a Lehman-crisis," the strategist said.

There has been an advance that began following record low yields in U.S. government bonds in late September.

Bond yields have had a "decent recovery from the bottom," the strategist said. "But it's been a heck of a correction on the way up."

The strategist believes that an answer about whether Europe has a credible plan will be forthcoming on Wednesday.

"It's for certain; that is the day of the announcement," he said, adding that he didn't think the markets would give the European leaders the luxury of additional time.

"The markets are backing them against the wall, and if you read the press statements, it's pretty explicit," he said.

In the meantime, the first Greek bailout loans are coming due by mid-November.

Provincial debt quiet

There was little change in the provincial bond market on Friday. But more primary action is anticipated given that the province of Ontario just came out of elections and is no longer in a blackout period.

The issuer can now resume a regular program of funding.

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