January Outlook
January 8, 2019  |  By Hank Cunningham

Evidence continues to accumulate that economic growth is slowing, both globally and in North America. Rising interest rates have had a negative impact on housing and vehicle markets, and manufacturing has crested with weak global PMIs and the U.S. ISM having its worst downturn in ten years.

Occurring against a backdrop of moderate, stable inflation, this slowdown is affecting the Federal Reserve and the Bank of Canada. Recently, the Federal Reserve signalled a more flexible approach to monetary policy; the futures market is forecasting low chances of Fed Funds increases this year.

Despite concerns in the credit markets towards the end of the year, the corporate bond market remains in decent shape but requires close scrutiny for possible over-leveraging and potential downgrades.

Bearish pressures remain, however, for bond prices. Inflation could rear its head, especially if the current rally in commodity prices continues. The combination of the ongoing monthly reduction in the Fed’s balance sheet plus a tsunami of new issuance of Treasury securities to fund the swollen U.S. Federal budget deficit should affect bond yields at the margin.

Changes in bond yields are nevertheless expected to be subdued and contained. With a more dovish approach by the Fed and bond yields at the low end of the forecasted range, the yield curve could steepen slightly. The current rally in energy prices and in commodities broadly, could push inflation modestly higher and push the ten-year yield back to the 3.00% - 3.25% area.

U.S. employment remains buoyant, supporting consumer confidence and spending, and this should be sufficient to avert a recession this year. The U.S. produced 2.6 million jobs last year and there remain 7 million unfilled jobs.

U.S. GDP growth should moderate below 3% while Canada’s should move below 2%.

Global growth should remain weak, but modestly positive. There are wild cards, particularly in the trade sector, but it is difficult to attribute anything to this important area.

With this moderate outlook, the U.S. dollar should weaken and in turn, could extend the current rally in commodities, assisting the Canadian dollar to advance.

Therefore, we expect U.S. two-year yields to remain close to 2.5% while the ten-year should fluctuate between 2.60% and 3.24%. Canadian yields will remain subdued; the yield curve should be relatively flat with yields close to 2% at all maturities. Mortgage rates, therefore, may decline somewhat. It will thus be another year of modest returns for fixed income investors.

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December Outlook
December 10, 2018  |  By Hank Cunningham

The economic outlook has dimmed during the past two months. Both the Federal Reserve and the Bank of Canada have softened their tone. While the Fed is almost certain to increase the Fed Funds rate in December, it might be the last hike for a while.

There are a host of positives still in place in the U.S. economy:

  1. Buoyant retail sales and consumer confidence.
  2. Increased business investment and industrial production.
  3. Tight labour market.
  4. Solid PMIs.

Global growth has been pared slightly by the OECD for 2019 but is still expected to be at 3.4%.

With one more Fed Funds hike coming and with inflation ebbing, the ten-year U.S. bellwether bond yield will not be climbing back to 3.24% anytime soon. That is looking like the market top for now. However, there is not a strong case for bond yields to fall further from current levels either, as a result of all the positive factors still present. Inflation may be ebbing but it is still in the 2% area, leaving real yields barely positive including the Fed Funds rate. The U.S. Treasury had to issue record amounts of bonds to finance the whopping U.S. deficit. With the flatter yield curve, the Treasury may begin to ramp up its issuance of long-term bonds.

Our conclusion is that there is no recession coming soon and that the fears surrounding the corporate credit market, both for investment grade and high yield bonds, are overblown. This is not to ignore them, but even with the recent widening of spreads from government bonds, corporate bond yield spreads are still historically tight. Long-term yields are near the bottom end of what we estimate to be the new trading range of 2.75% to 3.24%.

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November Outlook
November 7, 2018  |  By Hank Cunningham

The U.S. ten-year yield reached our year-end target of 3.25% briefly and has fallen modestly. All signs point to higher yields at all maturities. The Federal Reserve and the Bank of Canada are clear in their goal of “normalizing” interest rates, likely leading to a further increase of 100 basis points in administered rates during the next twelve months.

As for market yields, they are heading higher as the employment market remains strong with the unemployment rate at 3.7%, seven million unfilled jobs, and wage growth kicking in above 3%. Besides this, the U.S. Treasury increased its debt sales to $83 billion per quarter and the Fed continues to unwind its balance sheet.

Corporate bonds, both investment grade and high yield, suffered in October but remain at relatively narrow spreads from government bonds.

In short, we believe bond yields will continue to grind higher with a target of 3.5% to 4% for the bellwether U.S. ten-year.

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