Markets taking Canada’s downgrade in stride

Markets and economists are largely shrugging off Canada’s loss of its unanimous AAA credit rating.

“How would it feel if you threw a downgrade party and nobody came?” Scotiabank Economics asked in a research note.

On Wednesday, Fitch Ratings downgraded Canada from AAA to AA+, citing the large increase in budgetary deficits and the deterioration of the debt-to-GDP ratio as the government grapples with the economic fallout from the Covid-19 outbreak.

Despite the downgrade economists are largely sanguine on the move, noting that it wasn’t a surprise and that the underlying rationale reflects the unavoidable consequences of a global pandemic rather than a loss of fiscal discipline.

“Markets could not have cared much less, as government of Canada yields and the currency were unaffected,” Scotia said.

For now, Canada remains AAA-rated by the other big three rating agencies — S&P, Moody’s Investors Service and DBRS Morningstar.

In a research note, National Bank Financial Inc. (NBF) said Fitch’s rating approach considers the finances at all levels of government, not just the federal level. Deteriorating provincial finances due to Covid-19 “appear to be a contributing factor to the downgrade.”

Two of the other big rating agencies — Moody’s and DBRS — have recently affirmed Canada at AAA, NBF said.

“We’re still waiting to hear from S&P, which is a rating agency that carries a lot of weight and where the sovereign rating/ceiling has potentially broader implications, given that S&P rates more names in Canada,” it said.

As for whether the other rating agencies will downgrade Canada, BMO Economics said: “It wouldn’t be surprising at all to see, at minimum, some negative outlooks on the remaining AAA ratings. There’s still plenty of uncertainty on the shape of the recovery and fiscal path, particularly beyond this year.”

The one certainty is that the federal deficit will balloon to at least $250 billion this year, BMO said.

“But, the appetite for deficit reduction post-Covid will be a big question mark for some time,” it noted.

Still, the lack of immediate market reaction appears to reflect the fact that many other countries are in the same boat.

“One reason the loonie didn’t sell off too much might be the fact that investors know that all major developed economies are facing a very uniform shock to their economies and public finances. If Canada was best going in, on a relative basis, maybe they’ll still be best when the dust settles,” BMO said.

Scotia echoed this sentiment, saying, “Lagging ratings actions are a relative game, and the relatives aren’t looking so good these days.”

BMO said the Fitch downgrade “shouldn’t have a major impact on the market or borrowing costs,” but that it also “serves a message that Canada is not fiscally immune, and that governments will have plenty of work to do after the pandemic (and necessary support measures) come to pass.”