Canadian Bond

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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.

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MARKET COMMENTARY

Canadian Fixed Income

Fixed Income | June 27, 2018

Terry Carr, Head of Canadian Fixed Income

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

THE BACKDROP

In my view, the markets are less dangerous today than they were a year ago when the Bank of Canada (BoC) surprised everyone with its hawkishness, and yields are now significantly higher.

Markets have moved on from the extreme volatility that characterized February. But from what I can see there remains a tug of war taking place in the fixed income markets, essentially between the ‘risk off’ and the ‘risk on’ camps. The ‘risk off’ camp believes that we remain in the early stages of tightening, with several additional interest rate hikes likely, which have the potential to derail the economy. Meanwhile, the ‘risk on’ camp – whose views are more aligned with mine – thinks we’re already well through the rate hiking cycle and as such, sees opportunities ahead.

In my view, the markets are less dangerous today than they were a year ago when the Bank of Canada (BoC) surprised everyone with its hawkishness, and yields are now significantly higher. That said, interest rates remain low by historical standards. The key question on everyone’s mind is: as we head towards ‘peak rates’, at what point will it begin to hurt growth, and how will it impact traditional ‘risk on’ assets such as real estate and the corporate bond market?

In terms of central bank action, I believe the US Federal Reserve will stay true to their ‘dot plot’ so we should see two more hikes this year. I expect the BoC to hike once more this year. I doubt they will go for a third rate hike this year unless trade tensions abate.

As alluded to in the last publication,1 risk factors are emerging for the Canadian economy. They have come into focus a little more in the last three months – real estate, higher minimum wages, NAFTA, trade tariffs and more recently, concerns about Canada’s competitiveness. Following recent US tax reforms, Canada is no longer the lower tax jurisdiction relative to its neighbor.2 Understandably, the country’s ability to attract business investments is being questioned.

In the last few months, fixed income investors have also kept a watchful eye on the recently concluded provincial election in Ontario. The province, which contributes the most to Canada’s GDP,3 also carries the distinction of being the most indebted sub-sovereign entity in the world.4 Concerns that fiscal deficit at the province level could rise further if left unchecked had placed a cap on the strength of the Canadian Dollar. With the Progressive Conservatives of Ontario now set to assume office, there has been some slight tightening of spreads as markets hope for improved discipline.

Global Intelligence Interim Outlook June 2018 - Canadian Fixed Income: Opportunities For Investor Icon

OPPORTUNITIES FOR INVESTORS

Overall, we remain constructive on corporate credit.6 But given where we are in the interest rate cycle, it would be sensible to dial down one’s enthusiasm slightly.

An area where we are seeing interesting opportunities is at the long-end of the high quality, highly liquid corporate debt curve. In our view, demand for these issues could rise as life insurers look to ‘upgrade’ their portfolios in response to the new LICAT (Life Insurance Capital Adequacy Test)5 which requires, among other things, life insurers to set aside more capital against investments allocated to more risky asset classes.

Overall, we remain constructive on corporate credit.6 But given where we are in the interest rate cycle, it would be sensible to dial down one’s enthusiasm slightly. The team believes it makes sense to keep one’s powder dry for when opportunities reveal themselves, as they could in times of increased volatility.

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

RISKS

We continue to have a cautious view of the energy sector – pipeline capacity issues continue to hinder the sector’s development.

We continue to have a cautious view of the energy sector – pipeline capacity issues continue to hinder the sector’s development. The Canadian government’s decision to buy Kinder Morgan’s Trans Mountain pipeline in a bid to save the project has angered environmentalists and faces political hurdles at the provincial level. This has been a key reason why the Canadian energy sector has not benefitted more from the recent rally in oil prices. The prolonged bickering between the province of British Columbia and Alberta over a project that can help unlock Canada’s ‘trapped oil’ has adversely impacted credit spreads within the space.

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

ON OUR RADAR

The decision to nationalize the Trans Mountain pipeline is noteworthy.

The decision to nationalize the Trans Mountain pipeline is noteworthy; the fact that the private sector walked away from an economically important, government-sanctioned infrastructure project has raised serious concerns about the ease of doing business in the country. We will monitor developments closely.

1 Manulife Asset Management: Global Intelligence – Canadian Fixed Income, April 3, 2018.
2 EY: How US Tax Reform Will Affect Canada’s Competitiveness, January 1, 2018.18.
3 Statistics Canada, November 2017.
4 National Post: How Crushing is Ontario’s $312 Billion Debt?, March 22, 2018.
5 You can find out more about LICAT at the Office of the Superintendent of Financial Institution’s website.
6 Bloomberg, as of May 23, 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.