Fixed Income

January 2020 Fixed Income Review

A cocktail of unforeseen geopolitical headlines destabilised markets in January.
February 2020
Subscribe to our insights

Monthly Fixed Income Review

Interest Rates

 The assassination of a top Iranian general early in the month followed by the Coronavirus outbreak presented new uncertainties for market participants to digest in the New Year, and sparked a flight to quality bias which pushed yields broadly lower.

  • The Bank of Canada kept interest rates on hold at 1.75% at their January meeting, but turned decidedly more dovish in response to largely disappointing Canadian economic data. Interest rates responded rapidly to fully price-in more than one cut for 2020.
  • Canadian 10yr interest rates fell by -43bp to close at the period lows of 1.27%, while U.S. 10Yr yields fell -41bp to 1.51%.
  • Both the U.S. and Canadian curves (as measured by the differential between 2yr and 10yr yields) flattened materially as yields fell. The yield curve in Canada flattened by -16bp and by -15bp in the U.S.

Credit Spreads

  • Corporate yield spreads in Canada were flat over the period, outperforming US spreads and US-based credit derivatives, both of which widened on a mixture of heavy supply and geopolitical concerns.
  • Supply in Canada was moderate, as financial issuers focused on issuance in non-Canadian markets. This supported Canadian spreads relative to global markets.
  • 10yr provincial spreads (as measured by Ontario) widened by +5bp to 64bp, driven by a combination of de-risking and rate-lock selling activity at low outright yields (currently just below 2.0%).
  • S. investment grade credit default swaps widened by +6bp, and high yield cash was out by +53bp.

Market Expectations / Portfolio Implications

Interest Rates

The Canadian economy continues to show evidence of sluggishness, and the Bank of Canada responded by walking back some of their recent optimistic rhetoric. Following the month’s developments, Canadian 10yr and 30yr yields now trade well below the overnight rate, suggesting that inflation is not perceived as a concern by the market, and that the BoC may need to respond more aggressively in order to un-invert the yield curve. Put another way, at current market levels, an investor can sell 10yr Canadian government bonds to buy Canadian T-Bills and pick up +35bp, which might suggest the BoC is lagging too far behind the curve. The U.S. bond market is similarly priced for cuts, and the 3M-10yr yield spread re-inverted at the tail end of January, which is weakening the Fed’s case for keeping rates on hold this year. In fact, the last Fed Dot-Plot survey shows the Fed hiking in 2021, while current market pricing suggests cuts in 2020. That being said, the rate rally so far this year has been particularly violent, and a moderate pull-back or consolidation period could be in the cards in the near-term. Given what’s already priced, the portfolio manager sees an opportunity to reduce an overweight duration / curve flattening position, with potential to re-establish at more favourable levels.

Credit Spreads

While credit remains largely a carry game, low and in many cases negative interest rates around the world have driven market participants deeper into the risk spectrum in the pursuit of yield pickup. This activity has driven spreads to multi-year tights, and would seem to suggest that the concept of risk itself has either lost some element of its meaning, value, or perhaps both. Narrow credit break-evens also indicate that there is little cushion should things go wrong, and the recent Wuhan Coronavirus outbreak has potentially provided a catalyst for credit investors to reassess whether they are being sufficiently compensated for risk within their portfolios. While spreads broadly widened from recent tights set in January, the move is not particularly significant from a historical standpoint and the market tone remains more or less healthy for the time being. Should markets stabilize in the near-term, issuers will be tempted to borrow at current low all-in yields, which may bring about a wave of supply. The portfolio manager prefers to be patient on credit and wait for more compelling break-even levels prior to establishing an overweight credit position.

 

To learn more about our Fixed Income products, connect with a BMO representative.

Subscribe to our insights
Inscrivez-vous à recevoir nos perspectives

Disclosures

This update has been prepared by BMO’s Fixed Income Team. This update represents their assessment of the markets at the time of publication. Those views are subject to change without notice as markets change over time. The information provided herein does not constitute a solicitation of an offer to buy, or an offer to sell securities nor should the information be relied upon as investment advice. Past performance is no guarantee of future results. The statistics provided in this update are based on information believed to be reliable but not guaranteed. This communication is intended for informational purposes only.

Certain of the products and services offered under the brand name BMO Global Asset Management are designed specifically for various categories of investors in a number of different countries and regions and may not be available to all investors. Products and services are only offered to such investors in those countries and regions in accordance with applicable laws and regulations.

Certain statements included in this material constitute forward-looking statements, including, but not limited to, those identified by the expressions “expect”, “intend”, “will” and similar expressions. The forward-looking statements are not historical facts but reflect BMO AM’s current expectations regarding future results or events. These forward-looking statements are subject to a number of risks and uncertainties that could cause actual results or events to differ materially from current expectations. Although BMO AM believes that the assumptions inherent in the forward-looking statements are reasonable, forward-looking statements are not guarantees of future performance and, accordingly, readers are cautioned not to place undue reliance on such statements due to the inherent uncertainty therein. BMO AM undertakes no obligation to update publicly or otherwise revise any forward-looking statement or information whether as a result of new information, future events or other such factors which affect this information, except as required by law.

BMO Global Asset Management is the brand name for various affiliated entities of BMO Financial Group that provide investment management, retirement, and trust and custody services. BMO Global Asset Management comprises BMO Asset Management Inc., BMO Investments Inc., BMO Asset Management Corp., BMO Asset Management Limited and BMO’s specialized investment management firms. Certain of the products and services offered under the brand name, BMO Global Asset Management are designed specifically for various categories of investors in a number of different countries and regions and may not be available to all investors. Products and services are only offered to such investors in those countries and regions in accordance with applicable laws and regulations.

®/™Registered trade-marks/trade-mark of Bank of Montreal, used under licence.

Related articles
No posts matching your criteria