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 signaled 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.