FidelityConnects: Fixed income in focus: Navigating rate moves from the BoC and the Fed

[00:04:33] Pamela Ritchie: Hello, and welcome to Fidelity Connects. I'm Pamela Ritchie. The Bank of Canada and the Federal Reserve have slashed their benchmark rates by a quarter point each. It is the Fed's first cut of 2025 and the Bank of Cananda's second, a move that sent North American equities higher and strengthened, of course, the U.S. dollar. Canadian yields have historically followed U.S. Treasuries but our next guest wonders is that relationship beginning to shift? This is the interest rate differential discussion. Joining us here today to unpack what the latest rate cuts might mean for tariffs, mortgage rates and investments is fixed income portfolio manager Lee Ormiston. Lee, great to have a moment to speak with you after these rate cuts were announced. How are you?

[00:05:18] Lee Ormiston: Doing well, thanks. How are you?

[00:05:19] Pamela Ritchie: Very well. Do you get popcorn to watch these announcements being made? Is this your version of, I don't know, film festival?

[00:05:27] Lee Ormiston: I mean, it's certainly talked about that we should have popcorn but definitely there's a little bit ... I mean, the reality is the market shuts down, our market shut down. We've had corporates fly every day this month except for yesterday. Everything shuts down and we just sit back and kind of watch and wait and see what's going to happen.

[00:05:46] Pamela Ritchie: There they were. They were pretty not very well kept secrets. We pretty much assumed both of those rate cuts were going to happen. In Canada, let's begin with the Bank of Canada. They were earlier in the day yesterday. They went through kind of the three main issues, labour being one of the reasons, one of their first reasons. Taking a look at what's different from July, inflation, they gave a few reasons for why that's different. The removal of the retaliatory tariffs just seemed to overall take away sort of a, phew, less inflation within the whole system. What did you take from it? What was the tone, did you think, from the Bank of Canada?

[00:06:28] Lee Ormiston: Those are the big three. I think that's what most people are focusing on. The reality is that we've had negative economic surprises over the last month or so. They didn't focus on it too much. They said the labour market softened but the reality is we've seen negative payroll growth on a 3-month and 6-month average. That's not something they want to highlight because of the potential to get people very concerned about it but that's one of the things that's in the backdrop that forced them to hike, or forced them to cut.

[00:07:02] Pamela Ritchie: It's interesting, so getting down into this lower range and discussion for maybe more cuts, off the top did you think that more cuts are absolutely baked in? I mean, markets have their own view of this. I'm kind of curious what you think.

[00:07:19] Lee Ormiston: I think that there are a couple of ways to think about this. They removed the language that basically tied the next cut to lowering inflation. There are a couple ways you can read all of this. There's some people out there who think that they'll just go consecutively. We think they'd probably skip a meeting and go in December. You've got market pricing that's about three-quarters of a cut right now, or about 80% of a cut is priced in by the end of the year so markets are expecting them to get to 2 1/4. I think that's probably a good spot. I would just note, that's at the bottom end of their neutral range so they're still neutral, they're not easy yet but they're at the lower end of the range so you could call it closer to being easy.

[00:08:07] Pamela Ritchie: Interesting. They got asked the question whether they're going to wait until they hear the Canadian budget, that was easily punted, the answer of the question. That said, it may be a slightly new outlook. They are looking to be better with their outlooks. They sort of spoke about the forward guidance being on pause, we know that, and they'd like to get back to that.

[00:08:30] Lee Ormiston: He did punt on the fact that the budget was supposed to be released after the next meeting. I would be surprised if he didn't know what was going to be in that budget before they walked into that meeting. I don't think that's a big concern. I think they'll have a pretty good handle on what the budget's going to look like going forward. I will note on the budget, most people expect the budget deficit to go to 2% of GDP, that's been consensus for quite a while but we saw in that press release that they're talking about a substantial deficit so to my mind does that mean more than 2%?

[00:09:08] Pamela Ritchie: Okay, even more therein. It's interesting on just sort of broadly taking a look at fixed income in Canada with rates coming lower and the overall impact that that will have on rates across a variety of asset classes. There's less of this you're getting paid to be patient, you're getting a little bit less cash from sort of a fixed income perspective because rates have come down. It's a different regime. How does that switch up for investors in Canadian fixed income markets?

[00:09:41] Lee Ormiston: Rates have definitely rallied into both of these meetings. We've seen it come off of the highs over the summer. There's still two-sided risk in fixed income if you look at where base rates are. Then you add ... so our corporate index is another hundred basis points.

[00:10:10] Pamela Ritchie: It does appear that the discussions about CUSMA or USMCA or whatever you want to call it, free trade deal, that has to an extent protected part of the Canadian economy except for the sectors that have been very badly hit. It sounds like those discussions are basically ramping up. We've got the Prime Minister in Mexico today and it just sounds like the renegotiation of that may come faster than not as fast in 2026. Is that, again, is that investible, is that useful? It's the certainty question, pretty much.

[00:10:47] Lee Ormiston: At this point it's hard to invest, to put anything with any kind of certainty on it given that Trump's been ... he's changed things quite a bit. That would be a challenge. I would note that Canada's done a fantastic job of moving much of its exports to CUSMA compliant. That means that [indecipherable] tariff rate in Canada is 5 to 7% so that's definitely helped Canada quite a bit. As far as a hit to Canada going forward on a renegotiated CUSMA, that's harder to gauge right now.

[00:11:26] Pamela Ritchie: We did certainly hear a focus at the end of the press conference yesterday with Tiff Macklem getting questions and then he gave extended answers about the importance of exports, which isn't a huge surprise but he really kind of hung on that one for a bit, watching exports extremely carefully going forward, essentially, it's important for a nation like Canada.

[00:11:48] Lee Ormiston: Yes, yes it is. I mean, especially with a substantial portion of the exports heading south, I mean, clearly the focus is to find new trade routes, possibly new oil pipelines, oil and gas pipelines that can route Canada away from the U.S. Interestingly, we saw a former Fed president talking about how many nations are trying to focus trade away from the U.S. and he specifically called out the work that Canada is doing.

[00:12:21] Pamela Ritchie: Yeah, interesting. Let's switch to the U.S. The Fed announcement in the afternoon, that's when you really do kick back and the markets begin again, the popcorn is eaten. So there we go. Immediately it was controversial out of the gates because Jerome Powell went ahead and said, yeah, there's inflation, m'hmm, and here's a cut. So it immediately sort of drew that ire from those that were going to be critical of that. I mean, I guess, yeah, we'll start with why.

[00:12:53] Lee Ormiston: Why would they cut? Well, there is a reason for them to cut. Inflation is still above target in the U.S., core inflation is still in the 3s so that's probably not great. The reality is the labour market in the U.S. has also slowed. We have an interesting dynamic that's going on in the U.S. and in Canada where you've got immigration has slowed so that means that the growth of the labour force has slowed. As that slowed, at a time when both economies are slowing you're also seeing companies need less new hires. They've kind of happened at the same time. We saw a payroll report of 22,000 jobs, that's well below most estimates of what a steady-state labour force growth needs to be, even with the decline in immigration. There is some concern there. He did spend some time talking about a risk management cut, that was viewed as somewhat hawkish. The opposite would be that the dots are projecting more cuts now than they were in the June meeting.

[00:14:08] Pamela Ritchie: Let's go to the other members of the Fed. This is a point of fascination. It brings in the Fed independence discussion but let's start with the dot. I mean, it was consensus except for one.

[00:14:21] Lee Ormiston: That's right. Yeah, so we had Stephen Miran, he dissented looking for 50 basis points. Not a surprise to anyone, we knew that from his public speaking ahead of this and his alignment with Trump. He was previously reporting directly to Trump or to the administration so that's not a big surprise. One of the other surprises though, one of the things that did surprise some people was the fact that Waller and Bowman did not dissent, they voted for 25. They had been pretty explicit ahead of this in looking for cuts. Maybe they pushed the committee there and got their cut and were happy with it. For the people that are highly concerned about Fed independence you could read into this that maybe the independence of the Fed is more durable than we would otherwise think.

[00:15:15] Pamela Ritchie: Because those particular names seem to be more aligned with what the administration would like to do?

[00:15:25] Lee Ormiston: That's right. Bowman is already vice chair. She probably doesn't need a new job. Waller would like to become the chair of the board of governors, he's always been perceived to be doing Trump's bidding but I think the fact that he only went for one cut this time shows that he might be a little more independent.

[00:15:46] Pamela Ritchie: There is this discussion of regime change in lots of different ways. It may end up being sort of the phrase of the year, regime change, because it's in so many different areas. One of the discussions is that a slightly hotter inflationary environment cuts into it, is all coming from perhaps Scott Bessent to the administration with the goal of what? How would you describe it? We can read some of this but what is the goal here?

[00:16:17] Lee Ormiston: Some of the explicit goals of the U.S. administration are to weaken the value of the dollar, close the trade deficit. One of the ways to do that would be run policy hotter than you otherwise would want. You talked about Bessent, some people are calling him a shadow Fed chair, he is somewhat dictating behind the scenes, or would be dictating behind the scenes to the new Fed governor, Fed chair what to do, how to do it. The market is taking comfort from the fact that the leading candidates are Hassett, Waller and Warsh so they're probably more mainstream than some other candidates might be and then with yesterday's vote from Waller. The market is a little more sanguine about the Fed running the economy hotter than it otherwise should. I would argue that if they did too much then they upset the apple cart, a little bit like what we saw in the bond market in April when long Treasury yields got to 5%. That was when we saw those pauses. We think that they probably will run it a little hot but they'll do it in a way over time that doesn't really cause any unrest among global investors.

[00:17:38] Pamela Ritchie: But the risk is there and so the discussion happens that what do you do in this situation that makes the long end really, really see rates just ratchet up and how do you ... is it important to have some version of yield curve control which is often mentioned in other markets, not necessarily in the United States, and that somehow there's a buying of those bonds at the long end to just kind of bring down the overall yield story there. That would normally be done by a central bank. This discussion seems to be enter Treasury and perhaps they'll be the ones taking some of those off the market to control a very steepened yield curve, should that happen. Just give us some context for those that are reading these thinking, huh? Why would we be talking about that and why is it important?

[00:18:33] Lee Ormiston: You're talking about YCC, yield curve control, or fiscal dominance or other people call it financial repression, where you keep rates lower than they otherwise should be. The examples we've seen in the past, especially post-World War II, where the Fed actually did control the level of rates and did it without needing to buy too many bonds, that would be an expansive balance sheet process for the Fed. The commentary we've heard out of Bessent, out of Warsh and to a certain extent, Stephen Miran, is they're less favourable on a large Fed balance sheet. That means in order to control 10-year rates, and Bessent has been very explicit about keeping 10-year rates low because that's the pass-through, the direct pass-through to mortgage rates in the U.S. The mortgage market and the housing market in the U.S. has been quite weak relative to other things, so explicit focus from the Treasury on the 10-year rates. How do they get there?

[00:19:34] If you don't use YCC, if you don't have the Fed buying 10-year notes,  the other way to do it is to just issue less 10-year notes. The market expects that Treasury issuance in total will need to climb over the next year as deficit grows. There's been some mitigation of that with tariff receipt but the consensus is total Treasury issuance needs to grow over the next year. In the past they've targeted a certain percentage of that as bills, as Treasury bills, so three months to a year, or even shorter. The rest goes into long bond auctions, so 2s, 5s, 7s, 10s, 20s and 30s. The concern from the market has been that they'll increase the ramp-up issuance in 10, 20 and 30-year notes but the read-through that we're getting from Bessent is they will probably instead just issue more Treasury bills. They've got a couple of different ways to pull that lever but we think that they'll probably issue more Treasury bills. If you have a Fed that's complicit in keeping the overnight rate low then you're also reducing the borrowing cost for the U.S. Treasury.

[00:20:43] Pamela Ritchie: And I guess it's just sort of that changing of who's doing the buying or the yield curve controlling, especially whether it's Treasury or a central bank. That would be one big difference.

[00:20:55] Lee Ormiston: Yeah. At the end of the day they're trying to get to a targeted level on the 10-year rate. The reality is this is actually not new. We saw this during the GFC. Treasury Secretary Geithner and Ben Bernanke, they met ahead. Before the Fed launched QE in the GFC they talked and they made sure that if Bernanke was going to increase and conduct open market purchases of 10-year Treasuries, Geithner wasn't then going to go out and issue a bunch more 10-year notes. There has been some, I mean, they have to work together to a certain extent and we've seen that [inaudible].

[00:21:36] Pamela Ritchie: That's really, really interesting. Okay, we spent half of our discussion here on the central bank decisions and what they mean, ultimately. Now we're sort of dying to what it, ultimately, means no, what it means for you as an investor and how this has a bit of a follow through. The Canadian economy to you, if we start here, looks how? There's some soft patches and there's just been a cut and they are not unrelated. How do you invest into this? How do you look through the state of the economy right now and sort of your thoughts on it?

[00:22:09] Lee Ormiston: From the perspective of corporations, we're not really seeing any ... the major sectors in our market are banks, energy, cable telecom, those are the major issuers, we don't see any direct effect of the tariffs on their bottom line. It's more of an indirect slowing of the economy. How does that affect all of them? The bank is projecting 1% second half of the year so it's low growth but it's not no growth. To the extent we continue to see that then our corporate issuers will be in pretty good shape. Where we're seeing a little bit of a disconnect is going to be in the retail sector and that has to do with income cohorts. You're talking about upper income, they have wealth in financial markets and to the extent that we've seen gains in the financial markets they're feeling much more comfortable about spending. It's really the lower and middle-income cohorts. They're still spending to a certain extent but we're seeing probably more trade-down than any just cessation of spending.

[00:23:18] Pamela Ritchie: So in terms of going ahead through the investment channels all of the announcements that, I mean, some have come out, some are pretty long term, these major projects, as they're being coined by the government, to build up basically the infrastructure of Canada. None of it's happening today. Is it useful for your investments going forward? How far out do you have to look? Does it affect what you do at all?

[00:23:43] Lee Ormiston: I mean, it is affecting what we're doing. One of the things we're seeing is growth in the energy sector within generations. There are projects that are going on and that's going to bring in a couple billion extra supply in our market a year from that. If our corporate market is, call it, 100 to 130 billion a year in issuance we're going to see 2 to 3 billion extra in that sector, so pretty easily digestible. It is something we're keeping an eye on to the extent that it will affect spreads in those sectors. We're, obviously, focused on the individual tickers that will be issuing this. Again, it's a couple billion a year for the next ... 2 or 3 billion a year for the next 10 years so it's something we'll be mindful of but it will be hard to ... it's going to be a little hard to just put an explicit trade around that.

[00:24:36] Pamela Ritchie: Okay, it's something that ... and I think we spoke before, you gave sort of examples of big projects that get started, get rolling and then eventually they're of interest as an investment to what you're doing.

[00:24:47] Lee Ormiston: They'll come in, they'll come into our market, yeah. That's typically how it unfolds.

[00:24:52] Pamela Ritchie: That's typically how it unfolds. Would you say that the inflationary discussion from your perspective is somewhat under control? I mean, does it feel like basically what Tiff Macklem said yesterday? You're always going to be keeping a very close eye on inflation and where it's going. Is it all right for bond investors?

[00:25:13] Lee Ormiston: I think we're in a good spot, more so in Canada than the U.S. If you're talking inflation fighting credibility clearly the bank has that over the Fed right now. That would be hard to argue. There's a lot more concern about independence, fiscal dominance in the U.S. than Canada. That's why Tiff looked a heck of a lot more at ease than Jay Powell did yesterday.

[00:25:35] Pamela Ritchie: Yes, he did, absolutely. He does talk about scarring in the labour market, the concern about unemployment which is very high in this country, it's over 7% at this point.

[00:25:46] Lee Ormiston: Did take up.

[00:25:49] Pamela Ritchie: There is sort of this, again, a little bit of a transition. I don't know if it's a regime change but there's certainly things that are changing up within the labour markets here. To what extent are you watching that, that's sort of a data input but does it direct you at all?

[00:26:04] Lee Ormiston: It's a data input. I would say that the risk is firing, people getting laid off. Until you see that happening ... you can see a slowing of the economy, you can see hiring slow but until you get layoffs we don't see the types of things that hurt our sectors, really, it doesn't really happen. If you had layoffs then people are going to be ... it's going to be harder to pay their mortgage. You could argue that would hit the banking sector in it from a perspective of spreads. Yes, bank spreads will go out but from the safety soundness of their balance sheets we don't see it as a direct link there. Loan-to-value ratio is very strong. Most of the issuers they've underwritten, those people have really strong balance sheets away from just their home so probably less of a concern than you'd think, but it does [indecipherable] spreads to the extent we start to see a layoff.

[00:27:12] Pamela Ritchie: Tell us a little bit about the mix within the portfolios that you're managing, if you take a look at corporates and different asset classes within that versus government or provincial or so on. At one point provincial was looking pretty good but that was a few years ago and the rate story is pretty different.

[00:27:32] Lee Ormiston: Long Ontario spreads are at 80, we haven't seen that in a while so they have come in quite a bit. That's despite some pretty healthy issuance out of the provinces. We've talked in other podcasts that provinces do a fantastic job of managing Canadian investors by issuing overseas and so just when we think they need to bring a lot of paper they'll issue a bond in Euros or sterling or U.S. dollars. What happens is investors will sit around and wait for one of the provinces to issue debt and they'll sit on ... instead of buying bonds in the secondary market they'll sit on that order, they'll wait a few days. Hey, we think the province of Ontario is going to issue a bond this week and we'll wait for that. I'll buy those bonds on the [indecipherable] side.

[00:28:24] Pamela Ritchie: Really interesting. Is that at all unique? I mean, I'm sure other countries do that as well but...

[00:28:29] Lee Ormiston: I'm a big fan of the Treasury function in all of the provinces. They do a fantastic job of managing their spreads. The province of Ontario has tightened quite a bit but you're also seeing ... we've seen a little bit of a leaking in long utility spreads, they've gotten wider. Down the curve we've been favouring banks, bank spreads, we think they look attractive relative to the other sectors.

[00:28:57] Pamela Ritchie: Really interesting. You focus on Canada, that's where the investing that you're doing is of interest. There's much discussion about whether it's a corporate headquarter from Canada moving to the U.S. or at least there's a demand for more investment from said Canadian, maybe multi-national company, to be into the U.S. Again, from a perspective of how you're looking at this does that matter? That matters to our economy overall but does it matter to the companies that you're invested in?

[00:29:29] Lee Ormiston: It definitely does matter unless you're an exporter. Many of the companies that we look at have U.S. operations and sometimes Canada is second or third in terms of total revenues, but we really don't see a tariff impact or a border impact because their operation's in the U.S. and their operations in Canada are unique, they're sort of tightly closed around that so it's not subject to tariffs. Where you do have corporations that are manufacturing things in Canada to send to the U.S., we've seen them make attempts to route that production elsewhere and then make sure that their U.S. production stays in the U.S.

[00:30:14] Pamela Ritchie: This is what we're seeing. We're seeing lots of announcements about this all over the place. Just take us back ... because it sounded really good to hear about how, perhaps, other markets, other clients, people around the world, companies were looking at foreign direct investment in Canada. I mean, we're worried about that, right? Is it a proxy for the U.S.? At one point it was. How has that shifted with the tariff environment that we're in?

[00:30:40] Lee Ormiston: It's interesting, Pamela, we've actually seen the asset allocators who were previously maybe not under-indexed to Canada but they had more of their investments in the U.S., we've actually see money come back to Canada either a concern for the value of the U. S. dollar or just look at the inflation outlook for Canada and like that better. We continue to see money coming into Canada, more so on an asset allocation basis rather than any new foreign investors but to the extent that you're an asset allocator, global asset allocator, you probably have a little more money in Canada [inaudible].

[00:31:17] Pamela Ritchie: There's a couple of questions coming in. They might be slightly more equity focused. I'll put one of them to you, certainly. In your opinion will private investments in Canada increase to boost corporate earnings? It's not unlike what you were just discussing there, maybe a sort of piece of what you were discussing there.

[00:31:40] Lee Ormiston: One of the focuses, Carney's focus is to break down inter-provincial trade barriers. To the extent that we get some follow through on that  then, yes, you would definitely see we're going to open it up for a corporation in one province to expand their operations or acquire a smaller competitor in another province and then grow. I think that that is in the cards.

[00:32:06] Pamela Ritchie: So interesting to get your perspective. Thank you. Would you have a final comment on the central bank action of the week? Everyone's back at the ... markets can now function, they know what's going to happen, has happened.

[00:32:19] Lee Ormiston: We talked about this earlier, get your popcorn ready. We're not done yet, more so with the Fed, it's a longer unfolding story as to how central bank independence evolves.

[00:32:32] Pamela Ritchie: We really appreciate getting your perspective in the midst of all this. It's incredible to have the insight. Thank you for joining us, Lee. We'll see you soon.

[00:32:40] Lee Ormiston: Thank you, Pamela.

[00:32:41] Pamela Ritchie: That's Lee Ormiston joining us today taking a look at the fixed income markets, particularly across Canada, in light of the rate cuts that we've heard on both sides of the border. Coming up tomorrow a look of what is shaping the global health care sector with portfolio manager Alex Gold. He's expanding on discussions about innovations, the central role of U.S. policy and the shifts within U. S. health care policy and how investors need to be looking at that, demographic story which goes on, for sure, how this all comes in to shape the sector. That's for tomorrow.

[00:33:13] Monday, Fidelity Director of Global Macro Jurrien Timmer dives into the latest macro themes that are on his radar, also sharing his amazing charts and graphs and data to help you kick off your trading week.

[00:33:24] On Tuesday, institutional portfolio manager Scott Mensi. He expands on where he is finding opportunities and how Fidelity Tactical High Income Fund is currently positioned. You'll want to tune in for that. That's on Tuesday. Both of those will have live French audio interpretations, you can join us in either official language. Have a great rest of your day. I'm Pamela Ritchie.