Quebec ``Non'' may disappoint bond investors

[Reuter / Michael Peacock]

LONDON, Oct 31 (Reuter) - Quebec's ``Non'' to secession from
Canada may not meet with the resounding yes from international
bond investors many in the market expected, analysts said.
The narrowness of the vote, concessions from Prime Minister
Jean Chretien to keep Quebec in Canada and the possibility of
another referendum add up to a daunting list of imponderables.
``Near-term, it will depend on what the respective
governments say,'' Adam Chester, international bond strategist at
Yamaichi International here said on Tuesday. ``It was a very
close vote -- it hasn't killed the issue off.''
The people of Quebec chose by a tiny margin to remain part
of Canada in yesterday's referendum. Only 50.6 percent of those
who voted were against separation -- meaning secession was
defeated by a mere 50,000-odd votes.
Nonetheless, Canadian bonds jumped for joy, narrowing the
30-year spread to U.S. bonds by 20 basis points overnight. That
spread now stands at 168 basis points.
Two-year notes did even better, closing by 40 basis points
to their U.S. counterparts. ``The short end outperformed on hopes
of an interest rate cut,'' Chester said.
But he added a wave of profit-taking was now possible.
Kirit Shah, fixed income strategist at First Chicago here,
sees the spread between 10-year Canadian and U.S. bonds
tightening no further than 140 basis points from 151 currently.
``Longer-term uncertainty is actually greater,'' Shah said.
``There's the prospect of another referendum now.''
After the vote, separatist leader Lucien Bouchard said the
next bid for independence could come sooner than expected.
Stephen Lewis, director of research at London Bond Broking
Company, also sees little benefit from holding Canadian bonds.
``Profit-taking could well set in now,'' he said, noting Canada's
constitutional situation remains unresolved.
``The separatists will argue Chretien's concessions saved the
day. They will try to hold him to those pledges,'' Lewis said.
``That keeps the consitutional future of Canada uncertain.''
Canadian Prime Minister Chretien promised wholesale reform
of the constitution as a last-ditch measure to stave off defeat.
Lewis suggested investors seeking exposure to Canadian bonds
stick to the short end of the yield curve. ``We'll probably see
the Bank of Canada take advantage of the Canadian dollar's
strength and cut rates, which will help the short end,'' he said.
Chester is not so gloomy about Canada's prospects but agreed
much depends on what Prime Minister Chretien says near-term.
``If he says something of substance which the separatists
respond to, the Canadian market can continue to rally,'' he said.
In that case the U.S./Canadian 10-year spread could drop to
120 basis points, Chester said.
But Shah said for Canada to really take off, the dollar bloc
as a whole, comprising U.S., Canadian and Australian bonds, must
attract increased weighting away from Europe and Japan.
``That's not too likely,'' he said. ``Non-farms could be strong
this week which adds to the risk premium for the dollar bloc.
And there's the U.S. budget to worry about.''
U.S. October non-farm payrolls, due on Friday, are expected
to show robust growth after last week's GDP figures showed the
U.S. economy grew 4.2 percent in the third quarter.
But Shah added the Quebec vote and a partial recovery by the
stricken Mexican peso has taken some heat off the dollar bloc.
Lewis said the third member of the dollar bloc, Australia,
is as badly placed as Canada further out.
``The government is very unpopular there and will probably
try to ingratiate itself with the electorate in ways that aren't
helpful for the bond market,'' he said.