Extending Duration
RJ Steinhoff, CFA Investment Process
The Bank of Canada commenced hiking administered rates in March 2022 to quell inflation created by pandemic-related supply chain disruptions, the invasion of Ukraine, and unprecedented shifts in consumer behaviour. Canadian Core CPI exited 2022 at 5.6%, double the rate observed in 2021 and nearly five times 2020’s rate. Ten hikes and 475 basis points later, the overnight rate and deposit rate stand at 5%. The two-year Canadian government bond rate is just above 4.5%.
In response, Canadian corporate bonds experienced a rough patch. The S&P Canada Investment Grade Corporate Bond Index fell 8.7% in 2022, its worst year since the index launched in 2013.
While inflation and rates rose dramatically, we strategically kept the duration of our Investment Grade Income Model below the benchmark duration of approximately seven years. This decision tempered the impact of rising rates.
Now 20 months removed from the first hike, the Canadian economy has softened considerably and inflation expectations have cooled. Economists expect a paltry 0.7% growth rate for 2024 and unemployment to breach 6%. October’s Core CPI was down month-over-month and annualized inflation is forecasted to drop below 3% over the next two years.
We expect the Bank of Canada to stand pat with interest rates, and there’s a strong possibility of cuts starting in 2024. Consequently, we have switched our duration stance from below benchmark to above; we’re now targeting investment grade bonds with duration greater than seven years.
Canadian investment-grade bonds are now in a sweet spot—dominant businesses with solid balance sheets to weather economic weakness, and tailwinds around the corner when the Bank of Canada walks back recent hikes.
RJ STEINHOFF, CFA
HEAD OF RESEARCH
DISCLAIMER
The information contained herein is for informational and reference purposes only and shall not be construed to constitute any form of investment advice. Nothing contained herein shall constitute an offer, solicitation, recommendation or endorsement to buy or sell any security or other financial instrument. Investment accounts and funds managed by Generation IACP Inc. may or may not continue to hold any of the securities mentioned. Generation IACP Inc., its affiliates and/or their respective officers, directors, employees or shareholders may from time to time acquire, hold or sell securities mentioned.
The information contained herein may change at any time and we have no obligation to update the information contained herein and may make investment decisions that are inconsistent with the views expressed in this presentation. It should not be assumed that any of the securities transactions or holdings mentioned were or will prove to be profitable, or that the investment decisions we make in the future will be profitable or will equal the investment performance of the securities mentioned. Past performance is no guarantee of future results and future returns are not guaranteed.
The information contained herein does not take into consideration the investment objectives, financial situation or specific needs of any particular person. Generation IACP Inc. has not taken any steps to ensure that any securities or investment strategies mentioned are suitable for any particular investor. The information contained herein must not be used, or relied upon, for the purposes of any investment decisions, in substitution for the exercise of independent judgment. The information contained herein has been drawn from sources which we believe to be reliable; however, its accuracy or completeness is not guaranteed. We make no representation or warranties as to the accuracy, completeness or timeliness of the information, text, graphics or other items contained herein. We expressly disclaim all liability for errors or omissions in, or the misuse or misinterpretation of, any information contained herein.
All products and services provided by Generation IACP Inc. are subject to the respective agreements and applicable terms governing their use. The investment products and services referred to herein are only available to investors in certain jurisdictions where they may be legally offered and to certain investors who are qualified according to the laws of the applicable jurisdiction. Nothing herein shall constitute an offer or solicitation to anyone in any jurisdiction where such an offer or solicitation is not authorized or to any person to whom it is unlawful to make such a solicitation.
The Bank of Canada commenced hiking administered rates in March 2022 to quell inflation created by pandemic-related supply chain disruptions, the invasion of Ukraine, and unprecedented shifts in consumer behaviour. Canadian Core CPI exited 2022 at 5.6%, double the rate observed in 2021 and nearly five times 2020’s rate. Ten hikes and 475 basis points later, the overnight rate and deposit rate stand at 5%. The two-year Canadian government bond rate is just above 4.5%.
In response, Canadian corporate bonds experienced a rough patch. The S&P Canada Investment Grade Corporate Bond Index fell 8.7% in 2022, its worst year since the index launched in 2013.
While inflation and rates rose dramatically, we strategically kept the duration of our Investment Grade Income Model below the benchmark duration of approximately seven years. This decision tempered the impact of rising rates.
Now 20 months removed from the first hike, the Canadian economy has softened considerably and inflation expectations have cooled. Economists expect a paltry 0.7% growth rate for 2024 and unemployment to breach 6%. October’s Core CPI was down month-over-month and annualized inflation is forecasted to drop below 3% over the next two years.
We expect the Bank of Canada to stand pat with interest rates, and there’s a strong possibility of cuts starting in 2024. Consequently, we have switched our duration stance from below benchmark to above; we’re now targeting investment grade bonds with duration greater than seven years.
Canadian investment-grade bonds are now in a sweet spot—dominant businesses with solid balance sheets to weather economic weakness, and tailwinds around the corner when the Bank of Canada walks back recent hikes.
DISCLAIMER
The information contained herein is for informational and reference purposes only and shall not be construed to constitute any form of investment advice. Nothing contained herein shall constitute an offer, solicitation, recommendation or endorsement to buy or sell any security or other financial instrument. Investment accounts and funds managed by Generation IACP Inc. may or may not continue to hold any of the securities mentioned. Generation IACP Inc., its affiliates and/or their respective officers, directors, employees or shareholders may from time to time acquire, hold or sell securities mentioned.
The information contained herein may change at any time and we have no obligation to update the information contained herein and may make investment decisions that are inconsistent with the views expressed in this presentation. It should not be assumed that any of the securities transactions or holdings mentioned were or will prove to be profitable, or that the investment decisions we make in the future will be profitable or will equal the investment performance of the securities mentioned. Past performance is no guarantee of future results and future returns are not guaranteed.
The information contained herein does not take into consideration the investment objectives, financial situation or specific needs of any particular person. Generation IACP Inc. has not taken any steps to ensure that any securities or investment strategies mentioned are suitable for any particular investor. The information contained herein must not be used, or relied upon, for the purposes of any investment decisions, in substitution for the exercise of independent judgment. The information contained herein has been drawn from sources which we believe to be reliable; however, its accuracy or completeness is not guaranteed. We make no representation or warranties as to the accuracy, completeness or timeliness of the information, text, graphics or other items contained herein. We expressly disclaim all liability for errors or omissions in, or the misuse or misinterpretation of, any information contained herein.
All products and services provided by Generation IACP Inc. are subject to the respective agreements and applicable terms governing their use. The investment products and services referred to herein are only available to investors in certain jurisdictions where they may be legally offered and to certain investors who are qualified according to the laws of the applicable jurisdiction. Nothing herein shall constitute an offer or solicitation to anyone in any jurisdiction where such an offer or solicitation is not authorized or to any person to whom it is unlawful to make such a solicitation.
