Canadian Bond

INVESTMENT PHILOSOPHY

There are ‘pockets of value’ in the fixed income market. Thorough credit and curve analysis enables us to identify and exploit these pockets of value in the pursuit of long-term returns, while minimizing downside risk. Within this conservative framework we apply our creativity to generate innovative investment ideas, and develop state of the art portfolio management techniques, allowing us to remain at the forefront of the investment industry.

STRATEGY FEATURES

  • Dynamic and diversified exposure to core Canadian bond investment futures
  • Enhanced total return opportunity through an active approach to credit, sector and security selection
  • A deep, experienced investment team, backed by one of North America’s largest global credit research groups

MARKET COMMENTARY

Canadian Fixed Income

Fixed Income | October 11, 2018

Terry Carr, Head of Canadian Fixed Income

Global Intelligence Interim Outlook October 2018 - Canadian Fixed Income: The Backdrop Icon

The backdrop

“As of this writing, we expect the Bank of Canada (BoC) to increase their overnight rate a further 25 bps (basis points) to 1.75% by the end of 2018.”

Uncertainty still dominates—but the clouds may be clearing somewhat.

In our view, much of what could happen in the next 12 months depended on the outcome of the NAFTA negotiations. We now have a tentative agreement in the new United States-Mexico-Canada Agreement (USMCA). From an economic standpoint, the agreement largely maintains the continuity of the old NAFTA agreement with moderate quota concessions, in particular to the United States within the Canadian “supply management” system, covering dairy, eggs, and poultry.1 Generally speaking, the immediate economic impact on Canadian GDP growth appears to be immaterial, but for markets and business leaders, it should lead to more informed risk taking over the intermediate time horizon.

As of this writing, we expect the Bank of Canada (BoC) to increase their overnight rate a further 25 bps (basis points) to 1.75% by the end of 2018. However, the bank isn’t fully committed to providing forward guidance, which makes longer-term forecasting somewhat challenging. That said, we expect the interest rate differential between Canada and the United States to remain around 50 bps for the time being. Our base case is for the U.S. fed fund rate to end 2019 at 3%, with Canada’s overnight rate at 2.5%.2 The caveat here is that our projection is predicated on the USMCA agreement process staying on course, and that Canada’s political landscape isn’t dramatically reshaped by the public’s perception of the Trudeau government’s handling of the trade talks.

Adding to the uncertainty, the increased likelihood of yield curve inversion in both the United States and Canada which typically portends a recession. The yield curves have flattened over the last year and we believe an aggressive rate hike schedule and/or softer-than-expected economic data could hasten an inversion. While some commentators argue that a yield curve inversion in the United States might not lead to a recession in this instance, the latest research from the Federal Reserve Bank of San Francisco suggested otherwise.3 That said, it’s important to note that yield curve inversion in Canada isn’t as reliable a predictor of a Canadian recession. Regardless, we will be monitoring the shape of each country’s curve more intensely.

Global Intelligence Interim Outlook October 2018 - Canadian Fixed Income: Opportunities For Investors Icon

Opportunities for investors

As things stand, we believe it makes sense to be vigilant and to be a little more conservative than we would be otherwise.

Despite the ongoing uncertainty, it’s worth remembering that opportunities can come from surprising places: Canadian fixed income investors can benefit from economic weakness and volatility, stemming from some of the darker outcomes of these trade negotiations, through nimble portfolio positioning. Hypothetically speaking, a breakdown in trade talks could have led to a risk-off rally in Canada’s fixed income market, with perhaps a slight selloff in the credit market. But, as it turns out, this scenario is now a near-zero probability event, but as things stand we believe it makes sense to be vigilant and to remain a little more conservative given the complexity of global trade risks.

Global Intelligence Interim Outlook October 2018 - Canadian Fixed Income: Risks Icon

Risks

The issue of trade sits at the top of our list of concerns; however, Canada’s energy sector remains a close second and warrants continued monitoring.

We’ve written at length about trade negotiations. The issue sat at the top of our list of concerns. However, Canada’s energy sector remains a close second and warrants continued monitoring. While the summer months brought a mild recovery (energy stocks outperformed the general market and the sector’s credit spreads tightened somewhat), we have retained our cautious stance towards the sector.

The end of August, however, brought a surprise: Canada’s Federal Court of Appeal rejected the CAD$9.3 billion expansion plan for the Trans Mountain oil pipeline on grounds that Ottawa had inadequately consulted with the country’s indigenous groups. The ruling effectively means the project will remain in limbo for the foreseeable future. This illustrates how quickly things can change in the sector—one that finds itself at the center of social, political and environmental debate by default. Importantly, we are mindful that any change in the makeup of the U.S. Congress, as a result of November’s midterm election, could also have an impact on the sector.

Global Intelligence Interim Outlook October 2018 - Canadian Fixed Income: On Our Radar Icon

On our radar

“We will be keeping our eyes on the tightening of monetary conditions in North America and trade talks between the United States and China.“

We will be keeping our eyes on the tightening of monetary conditions in North America and trade talks between the United States and China. The outcome of these two events will have an outsized impact on global growth. The unpredictable nature of the discussions doesn’t help—suffice to say it’s going to be a nail-biter for quite some time to come.

1 United States-Mexico-Canada Agreement Text, Office of the United States Trade Representative, September 30, 2018.
2 Manulife Asset Management, October 5, 2018.
3 “Information in the Yield Curve about Future Recessions,” FRBSF Economic Letter, August 27, 2018.
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About the Author

2015 Apr Carr TerryTerry Carr

Terry Carr is Head of Canadian Fixed Income for Manulife Asset Management. He is responsible for the Canadian fixed income and money market teams and a senior member of the Manulife Asset Management Investment Committee.

The opinions expressed are those of Manulife Asset Management™ at the time of publication, and are subject to change based on market and other conditions. The information in this article including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Manulife Asset Management disclaims any responsibility to update such information. All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment or legal advice. Clients should seek professional advice for their particular situation. Neither Manulife Financial, Manulife Asset Management, nor any of their affiliates or representatives is providing tax, investment or legal advice. Past performance does not guarantee future results. This material was prepared solely for informational purposes, does not constitute an offer or an invitation by or on behalf of Manulife Asset Management to any person to buy or sell any security and is no indication of trading intent in any fund or account managed by Manulife Asset Management.