Fixed-income tips to beat Fed headwinds

In a fixed-income update, National Bank forecasts Fed rate hikes in June and September, with the Fed funds target range at 1.25% to 1.50% by year-end, and 10-year treasuries trading at about 2.95% going into 2018.

Read: Were they right? This PM’s ‘not loading up on bonds’

The bank is hardly alone in its forecast of two rate hikes. For example, portfolio managers Jeff Moore and Michael Plage of Fidelity Investments also forecast the hikes.

“The wild card is that the U.S. Federal Reserve might be spooked if the U.S. administration succeeds in providing fiscal stimulus and making tax cuts,” Moore and Plage say in a report. Further, they expect inflation of 3% to 3.5% by year-end, with a small risk of a higher inflation rate due to a potential surge in oil prices, a turnaround in deflationary food prices and robust job creation.

On this side of the border, a potential Bank of Canada rate hike in October will be influenced by how Trump handles NAFTA renegotiations and whether the president’s successful with his tax agenda, says National Bank.

“We will be watching the political scene and incoming economic indicators to gauge whether our current call of a Q1 2018 rate hike should be shifted to the fall of this year,” says National Bank in its update. “We see the odds of this happening in the mid-40s.”

Fixed-income positioning

Because of Fed headwinds and their view of the economic cycle, Moore and Plage allocate significantly less to U.S. treasuries than the benchmark. However, “Yields have increased somewhat over the last 12 months,” they note, “and treasuries are becoming increasingly more interesting as long-term investments. However, patience is our attitude for now.”

Read: Those bond funds are doing just fine

Their expectation of higher inflation mean they allocate “significantly more” than the benchmark to U.S. TIPS.

Here are further insights from Moore and Plage on current fixed-income investing opportunities:

• Global credit hedged to the U.S. dollar. Increasing their larger-than-benchmark position is aimed at achieving diversification, correlation and lower spread volatility compared with U.S.-dollar bonds. “The allocation remains only modestly larger than the benchmark’s, because valuations [in the U.S.] are also below 2016 levels,” they say.
• Non-dollar and non-U.S. dollar. Holdings remain modest (less than 1.5% of their fund’s fixed income), with most of the position in the peso, which has made solid total returns of late on, among other things, Bank of Mexico actions, they say.

Read National Bank’s update, which includes forecasted interest rates through Q1 2019.

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