March Outlook
March 11, 2019  |  By Hank Cunningham

After the Federal Reserve was joined on the sidelines by central banks in Canada, Europe, Australia and China, the bond market moved to a state of equilibrium, as bond yields respond to natural market forces.

Monetary policy moved away from further tightening in response to mounting evidence of slowing global economic growth. Some pundits are calling for rate cuts by the central banks.

This recency bias ignores the fact that global growth remains positive but at a slower pace. The U.S. economy is not immune to global conditions and there has been slowing in several key sectors such as auto sales, consumer confidence and home sales. At the same time, markets are catching a whiff of inflation, which has resulted in a steepening of the yield curve, particularly in the widening spread between 10- and 30-year Treasuries. The 30-year bond yield has added 15 basis points since the beginning of the year. Inflation expectations snapped back to near 2% on a 6% increase in commodity prices and wage gains.

There is little stress in the investment grade and high yield markets.

Meanwhile, global bond yields fell sharply. The German ten-year bund sunk to a mere 5 basis points! Thus, the U.S. bond market remains the high-yielding beacon among global bond markets and continues to attract international investors, especially given the strong dollar. Against this tug-of-war, U.S. ten-year bond yields could fall to 2.50%. The Fed is willing to tolerate inflation running above its 2% target, so if inflation does pick up further, upward bias would then return to bond yields, perhaps pushing them to 3%.

Canada experienced a dramatic slowing in GDP in Q4, with weakness in trade and retail sales evident. The Bank of Canada moved to the sidelines and, in a dovish announcement, pared its growth estimates considerably, leaving little doubt that it will remain on the sidelines indefinitely. Thus, Canadian fixed income investors are facing a period of flat to declining yields.

+Full Report

February Outlook
February 5, 2019  |  By Hank Cunningham

With the dramatic shift away from tightening by the Federal Reserve, the bond market will react to natural forces. Yields are locked in a narrow trading range with the ten-year anchored close to 2.70%. The two-year note slipped to 2.50%, thus contributing to a modest steepening in the yield curve. Conditions in the corporate bond market, both investment grade and high yield, have improved to a more normal state, with a steady flow of primary issues accompanied by narrowing spreads.

The bond market appears to be in a state of equilibrium, as inflation ebbs and growth slows. The ten-year yield should trade in a range of 2.50% to 3.00%. Close attention should be paid to inflation but any serious uptick seems unlikely.

The U.S. faces an avalanche of new Treasury issuance to fund its swollen deficit and it will continue to reduce its balance sheet, but on a flexible basis.

At the margin, the U.S. dollar could soften and with improvement in energy pricing and in other key commodities, the Canadian dollar could benefit further.

Fixed income investors can therefore look forward to another year of modest returns, in the 2% to 4% range.

+Full Report

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.

+Full Report

Special Reports