Now’s the time to overweight corporate bonds

Thursday’s rate announcement kept bond markets under a 0.25% regime, making it an ideal time to own higher yielding issues.

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And even if the Fed had raised rates, the market wouldn’t have been shocked, says Patrick O’Toole, vice-president of global fixed income at CIBC Asset Management and co-manager of the Renaissance Canadian Bond Fund, an underlying fund in the Renaissance Optimal Income Portfolios.

“We’ve been in a range of 120 to 190 [basis points] for a 10-year Canada bond yield” over the last six months, he adds. Now, “we’re stuck just a little below the middle at 1.5%. Even if the Fed had went [higher], that doesn’t change things much.”

Read: Which sectors benefit from low rates?

He expects a moderate rise in bond yields over the next six to 12 months “whether the Fed does raise rates or not.” That’s because “the economy is going to continue to progress. The U.S. economy is going to come in above 2%. Canada will struggle a little more vis-à-vis the U.S. than we’ve seen in the past few years, but the U.S. [recovery] is going to help Canada’s growth improve.”

Read: Would wage hike bolster U.S. consumers?

As a result, advisors don’t have to make any major adjustments to client portfolios. “It’s still an environment where you want to be overweight corporate bonds vis-à-vis government bonds,” says O’Toole. “The credit spread over a Government of Canada bond is still attractive, and that goes for the investment-grade or the high-yield corporate market.”

Read: Why companies issue high-yield bonds

Within corporates, O’Toole likes two sectors: communications and financials. Communications was “beat up a little bit earlier this year. There was a lot of supply [added] in the last 12 months, so, to digest that supply, we saw credit spreads widen out vis-à-vis other sectors.” He especially favours the telecom companies.

Read:

• Opportunities in the tech space
• Three reasons to invest in media companies

As for financials, “Certain issues still look attractive, particularly some of the U.S. ones.” He singles out Wells Fargo Canada as one option.

Read: Are banks keeping up with mobile trends?

Why the Fed didn’t hike

O’Toole says the Fed read market signals and chose to hold. “The Fed generally [doesn’t] increase interest rates unless the market is close to fully priced for a hike,” he says – and the market wasn’t.

Read: Huge letdown from the Fed

Even though the two-year Treasury note had priced in a hike, he explains, Fed Fund futures had not. Indeed, just prior to Thursday’s rate announcement, the CME Group’s FedWatch tool showed the probability of a hike at less than 25%. (As of Friday, it showed the probability of an October hike at 13.8%.)

Post-decision, “the reaction has been that the Fed is more worried than we thought about the potential for the economy to keep progressing like we’ve seen the past couple of quarters.”

O’Toole says the economic outlook is already positive. “The Fed’s own forecast for next year is 2.3% GDP growth, and that’s above-trend,” he points out. “That should have given the Fed some comfort to start to move off the emergency setting [by] actually hiking rates.”

Nonetheless, “The Fed [will] go slowly when they do raise rates.” For now, “The waiting game goes on.”

Read: Benefit from the Goldilocks environment

Melissa Shin

Melissa is the editorial director of Advisor.ca and leads Newcom Media Inc.’s group of financial publications. She has been with the team since 2011 and been recognized by PMAC and CFA Society Toronto for her reporting. Reach her at mshin@newcom.ca. You may also call or text 416-847-8038 to provide a confidential tip.