FIXED INCOME COMMENT- “Lower for longer…again”
The global economy entered 2016 with a similar outlook to 2015. In particular, world economic growth is projected to be approximately 3.2% in 2016, roughly matching 2015. The low global growth can be attributed to developed economies maintaining moderate growth and emerging market economies shifting to a slower growth trajectory. Global risks from 2015 have carried over to 2016 and continue to impact financial markets. These risks include: slower Chinese demand, falling commodity prices and elevated emerging market debt. As a result, yields on long-term government bonds fell to new all-time lows in Canada, the US, UK and Europe in the first quarter.
Although global risks have subsided from the beginning of the year, there is still a long road ahead. In the US, the Federal Reserve Board adjusted their forecast for the Fed Funds rate downward. As a result, we are anticipating one, maybe two rate hikes this year. The dovish tone was due to increased global concerns and low inflation pressures. In the UK, Brexit uncertainty, slower growth momentum and low inflation pressures will keep the Bank of England from raising rates this year. Finally, the European Central Bank will likely continue to expand their monetary policy stimulus through further rate cuts, expanded asset purchases, and liquidity providing measures.
The outlook for the Canadian economy in 2016 is one of slow growth due in large part to the continued decline in business investment that is related to the oil price collapse. The Bank of Canada’s overnight rate will likely remain at .50% for the balance of 2016. Contrary to earlier expectations of a rate cut, the decision to hold the rate is due to evidence of improvement in non-resource sectors of the economy. As well, there has been an increase in stimulus to help boost the economy. On March 22nd, 2016 the federal budget was released with plans to deliver a multi-year fiscal stimulus package. According to the finance minister, it will boost real GDP growth .5% in 2016-17 and 1% in 2017-18.
In 2015, it hurt investors’ relative performance to hold corporate and provincial bonds as yield spreads widened. As you know, when bond yields fall, bond prices rise. Last year, the yields on Canada bonds fell more than corporate and provincial bonds. As a result, Canada bonds had higher returns than corporates and provincials because prices rose more. So far in 2016, investor sentiment has improved in these sectors resulting in spreads narrowing. This has created an outperformance compared to Canada bonds. In the first quarter corporates returned 1.51%, provincials returned 1.64% while Canada’s returned 1.07%. What matters in the long run is that investors earn higher yields on corporates and provincials than Canada’s over the term of the bond. Going forward, we will continue to overweight corporate and provincials. Given the low level of interest rates and the poor return after inflation, we will maintain our underweighted position in bonds overall.