Ottawa's fiscal year shaping up better than budget forecasts: BMO economist

Key number: Ottawa's deficit for April–January is $31.2B versus the $78.3B annual deficit forecast in the 2025 budget, with two months remaining in the fiscal year. BMO economist Doug Porter expects the final FY deficit to come in below the November forecast, citing stronger-than-expected federal revenues and lower-than-projected interest costs on government debt, but warns March typically causes a large spike due to income tax payouts.

Analysis

A materially smaller-than-expected sovereign deficit is a classic supply-side shock to Canada’s yield curve: lower net issuance over the next 12 months should shave term premium predominantly at the long end. Rough bookkeeping — if net market borrowing is ~C$20–40bn lower than the budget path, expect a 10–30bp downward impulse to 10Y yields as dealers reprice inventory and duration-bearing money managers increase allocations; markets will price a large part of this within 3–6 months around the federal fiscal update.

Second-order winners are long-duration Canadian credits and rate-sensitive equities: provincial and IG corporate spreads typically compress 10–30bp when sovereign supply tightens, and utilities/REITs see re-rating as discount rates fall. Conversely, banks are exposed to a flatter curve and potential NIM compression over the next 6–12 months, and commodity exporters face two offsetting forces — weaker term premia (rate tailwind) vs a stronger CAD from improved fiscal optics (FX headwind to US$-priced revenues).

Key tail risks that could reverse the setup are front-loaded fiscal flows (March tax refunds) that re-inflate the deficit in the near term, an upward surprise in BoC policy or global inflation that lifts real rates, or a sudden widening of sovereign spreads if growth disappoints — each can re-steepen yields within days–weeks. For positioning, prefer tactical, basis-sensitive trades (duration vs credit, FX vs equities) rather than outright long-duration bets; liquidity will be decisive as dealers reallocate balance sheets ahead of the government's spring update.

Contrarian read: the market’s knee-jerk move to long duration may be overdone because the deficit improvement is revenue-driven and thus growth-correlated — if growth surprises persist, real rates can rise and offset the supply-driven yield decline. Hence, implement asymmetric trades that capture spread compression but cap exposure to adverse rate shocks over 1–6 months.

Key Decisions for Investors

• Long Canada 10-year government bond futures (or buy CA 10Y cash) — timeframe 1–6 months — target a 15–25bp rally in yields (i.e., price gain); set a stop if 10Y yield widens >12bp from entry. Rationale: reduced sovereign issuance should compress term premium; risk is BoC or global real-rate rise.
• Pair trade: short Canadian large-cap bank equity (e.g., RY.TO or BNS.TO) vs long Canadian utility (e.g., BCE.TO) — timeframe 3–9 months — target 8–12% relative return (bank downside vs utility upside). Rationale: curve flattening/NIM pressure hurts banks while lower discount rates help utilities; stop-loss if TSY/Can 2s10s steepens >15bp.
• Short USD/CAD (long CAD) via 3-month forward or spot — timeframe 1–3 months — target 3–4% CAD appreciation; stop if CAD weakens 2% from entry. Rationale: improved fiscal optics and lower expected sovereign supply are CAD-supportive; risk is US real-rate outperformance or commodity-driven CAD weakness.
• Long Canadian investment-grade corporate bonds (5–7y) or ETF exposure (e.g., XCB.TO) — timeframe 3–9 months — target 10–30bp spread compression; use a size that limits duration exposure to a 10–15bp move in sovereign yields. Rationale: dealer capacity freed by lower sovereign issuance compresses corporate spreads; principal risk is a parallel move up in sovereign yields.