May 11, 2018 | By Hank Cunningham
We believe that the uptrend in bond yields will continue and this means an unattractive risk/reward for longer dated bonds. The rising trend in short-term yields in North America, following increases in administered rates by the Federal Reserve and the Bank of Canada, has reduced the penalty for staying in short-dated bonds.
The U.S. economy may experience 3% real GDP growth this year. The employment market is taut and inflation has approached or passed the Central Bank targets. The housing market remains healthy, industrial production continues to pick up and consumer confidence is high. Inflation, while firming, is not an immediate threat to markets.
With this outlook as a backdrop, the Fed will continue to normalize short-term interest rates with at least two more increases in the Fed Funds Rate expected this year. The Bank of Canada has moved to a neutral position as it monitors the various headwinds affecting the Canadian economy. It will raise rates but will lag the U.S. Fed.
There is no change likely in the quantitative easing by either the European Central Bank or the Bank of Japan. Therefore, U.S. bond yields will stand out in global markets and attract foreign investors. While this will likely put a cap on bond yields (the 3% level on the ten-year has become a significant barrier), the heavy supply of new U.S. Treasury offerings plus the ongoing reduction in the Fed’s balance sheet will exert upward pressure on bond yields.
The recent sustained strength in commodity prices will also contribute to higher bond yields as inflation will inevitably accelerate to some degree.
With the odds of a recession occurring in the next two years being low, credit markets, both investment-grade and high-yield, are healthy and we do not anticipate any significant deterioration in corporate credit health.