Fixed income market commentary: Inflation, rates and global trade

WEBVTT

00:06.006 --> 00:09.009

Obviously, we've seen a big repricing of rates

00:09.009 --> 00:13.213

both in Canada and in the US over the past couple of months with rates up 50

00:13.213 --> 00:15.515

to 60 basis points across the curve.

00:15.515 --> 00:18.418

That's really been driven by three main factors.

00:18.418 --> 00:22.722

First, from a fundamental perspective, growth has been much better

00:22.722 --> 00:24.624

than expected and more resilient.

00:24.624 --> 00:26.993

Than the markets have been expecting.

00:27.994 --> 00:33.266

Second, inflation has obviously been the topical

00:33.266 --> 00:37.570

issue over the last number of months, especially with

00:37.570 --> 00:41.641

the events of the Middle East. So first, we've had continue to

00:41.641 --> 00:45.612

have sticky inflation, especially in the US post-pandemic, but also

00:45.612 --> 00:49.149

now with energy prices higher due to the conflict in the Middle Peace.

00:49.149 --> 00:53.086

We are starting to see concerns of that energy

00:53.086 --> 00:57.190

inflation potentially spilling over into

00:57.190 --> 01:01.461

other sectors. And so both the Bank of Canada and the Federal Reserve

01:01.461 --> 01:05.965

have shifted a little more hawkish more recently, highlighting the

01:05.965 --> 01:08.101

upside risks to inflation.

01:08.101 --> 01:12.072

And then finally, One of the other big topics right now is just

01:12.072 --> 01:16.209

the size of fiscal deficits in the US, the amount of government supply that

01:16.209 --> 01:20.313

could be in the market, and that's also pushing up term

01:20.313 --> 01:24.284

premiums in the U.S. Treasury market that's being pushed across to

01:24.284 --> 01:28.455

global rates. And then on top of that, we've seen record amounts of corporate

01:28.455 --> 01:31.357

supply, which has also been pressuring rates higher.

01:31.357 --> 01:35.328

So all of that together, we're now seeing this big repricing across

01:35.328 --> 01:39.432

the yield curve, but also we are now looking at markets pricing in.

01:39.432 --> 01:43.503

Five to six rate hikes in Canada over the next year,

01:43.503 --> 01:46.840

as well as three to four from the Federal Reserve.

01:46.840 --> 01:51.044

And so at these levels now, there is a lot priced into the markets and

01:51.044 --> 01:55.148

we're starting to feel that we are, the risk reward for owning

01:55.148 --> 01:58.985

duration and fixed income is starting to look much more attractive.

02:01.621 --> 02:05.925

Yeah, so there's no question that spreads are looking extremely tight

02:05.925 --> 02:10.096

on a historical basis. We are now, in many cases, at levels

02:10.096 --> 02:14.901

that are in the tightest percentiles post the global financial crisis.

02:14.901 --> 02:18.438

But that being said, there are a number of reasons that support valuations

02:18.438 --> 02:20.306

where they are currently.

02:20.306 --> 02:24.444

So first of all, corporate fundamentals have been extremely strong.

02:24.444 --> 02:26.179

Companies have been doing very well.

02:26.179 --> 02:29.282

Leverage is low. Earnings have been growing.

02:29.282 --> 02:33.319

So, from a fundamental standpoint, the corporate world has been

02:33.319 --> 02:37.390

doing very well. Secondly, higher yields have made fixed

02:37.390 --> 02:41.027

income much more attractive. We are seeing large amounts of flows into fixed

02:41.027 --> 02:45.131

income, and that is finding its way into the corporate bond market,

02:45.165 --> 02:48.334

keeping spreads well supported.

02:48.334 --> 02:52.639

And then finally, even though we've been seeing record amounts of

02:52.639 --> 02:56.176

supply, a lot of that supply has been absorbed by the amount of demand that

02:56.176 --> 02:59.412

we're seeing across the curve. Now, there's no question that spreads are tight

02:59.412 --> 03:04.184

and the prospects of further tightening are

03:04.184 --> 03:08.188

likely pretty limited, but given all of these positive

03:08.188 --> 03:12.325

support and fundamentals and technicals in the market,

03:12.325 --> 03:15.328

there is also no reason to see spreads going wider.

03:15.328 --> 03:19.399

So my opinion is that a modest allocation to corporates

03:19.399 --> 03:23.503

is still warranted, especially And because that extra spread, one,

03:23.503 --> 03:26.172

enhances the yield in a portfolio, but also...

03:26.172 --> 03:30.276

Provides you a cushion against the rate volatility that we have

03:30.276 --> 03:31.277

been seeing lately.

03:33.880 --> 03:37.917

So the trade uncertainty has obviously

03:37.917 --> 03:41.921

been front and centre with the back and forth between Canada and the US.

03:41.921 --> 03:45.959

The biggest concerns a lot of people talk about is the cost of goods

03:45.959 --> 03:50.797

and the inflationary impacts that it could have.

03:50.797 --> 03:53.900

But the thing I would point out is that when we think about the broader

03:53.900 --> 03:58.104

inflation backdrop, what we're seeing globally in terms of energy prices

03:58.104 --> 04:00.974

and other sticky inflation.

04:00.974 --> 04:05.011

Is a much bigger issue on the inflation front than sort of the tit

04:05.011 --> 04:09.749

for tat in terms of like the domestic battle

04:09.749 --> 04:11.951

between Canada and the U.S.

04:11.985 --> 04:16.122

So the bigger concern is really what does

04:16.122 --> 04:18.458

the trade uncertainty mean for growth?

04:18.458 --> 04:22.262

And when we think about that, there are a number of sectors that are obviously

04:22.262 --> 04:26.232

directly impacted, but more broadly speaking, the uncertainty that

04:26.232 --> 04:30.603

it creates. It has an impact on business investment and

04:30.603 --> 04:34.641

capital spending plans and so that's where the real risk lies

04:34.641 --> 04:39.078

in that if we don't get clarity over the trade conflict

04:39.078 --> 04:43.316

what we will see is that start to impact potential growth

04:43.316 --> 04:47.587

in Canada and as the Bank of Canada mentioned there is already some

04:47.587 --> 04:51.958

lack in the economy, so that's a risk to a future slowdown.

04:51.958 --> 04:55.995

And so that backdrop is somewhat at odds with what we're

04:55.995 --> 04:59.999

seeing priced in the markets right now because of the concerns around inflation

04:59.999 --> 05:04.203

and funding needs and elevated and pushing rates higher and

05:04.203 --> 05:08.441

pricing in a large number of rate hikes over the next year.