Bond yields are likely to remain low, says CIBC’s Patrick O’Toole, after the Bank of Canada’s wait-and-see-approach in its October rate decision.
After two consecutive rate hikes, the Bank of Canada maintained the overnight rate at 1% on Oct. 25, citing uncertainty around NAFTA renegotiations and expectations that the Canadian dollar’s strength would slow inflation. As of Nov. 10, the loonie was sitting close to US$0.79, only slightly down from its fall peak of around US$0.82.
“For about every three cents of appreciation of the Canadian dollar, that’s equivalent to about 100 basis points or a whole percentage point of a hike by the Bank of Canada,” says O’Toole, vice-president of global fixed income at CIBC Asset Management. He co-manages the Renaissance Canadian Bond Fund, an underlying fund in the Renaissance Optimal Income Portfolios.
The Canadian dollar was at US$.078 when the Bank made its most recent rate decision, presenting a potential headwind for the Canadian economy going forward, says O’Toole. The Bank likely wanted to see the implications of those headwinds before moving the lending rate again, he adds.
For Canada, O’Toole predicts growth of around 2% for the next 12 months. That’s in line with the Bank’s forecast that inflation would rise to 2% in the second half of 2018. (For more on the economic outlook for Canada, read Slower Growth for Canada in 2018.)
Even if, longer-term, central banks around the world gradually move to raise interest rates to more “normal” levels, O’Toole says bonds yields should remain low.
On Oct. 26, the European Central Bank said that while it would ease the pace of its bond-buying stimulus program, it would continue its purchases until at least September 2018. In the U.K. – where inflation is closer to 3% and nearly double that of the EU – the Bank of England raised interest rates for the first time in a decade on Nov. 2, but said the effect would be modest.
Read: Bank of England hikes despite Brexit concerns
While the longer-term return to “normal” interest rates could impact bond yields, O’Toole says it won’t change the mix of government and corporate bonds in his portfolio.
“We’ve been of the view these last several years [that] corporate bonds were going to win the day and that has been the case,” he explains. “The economy’s been OK, the back drop is constructive for economic growth, and that follows through to corporate bonds — they generally outperform government bonds when that’s happening. In particular, it tends to happen as interest rates do rise also.”
Canada’s growth may be slowing after a hot first half of 2017, to more moderate levels, but O’Toole hasn’t changed the outlook for his portfolio. “We continue to think that yields could move a little bit higher but it’s not going to be anything too dramatic given growth is reverting back pretty much close to trend levels,” he says.
What to look for in the week ahead
Markets hitting highs? Don’t panic