Fixed Income Monthly Monitor – February 2024

MARKET UPDATE

After a strong end to 2023 with falling rates and narrowing credit spreads, the new year got off to an exhausted start. Sentiment wavered somewhat as investors contemplated the prospect for aggressive monetary policy easing in an environment of still-robust growth and elevated inflation. In what was a busy month on the central bank calendar, policymakers cemented the end of their aggressive tightening campaigns and are shifting their focus to when to begin easing policy. However, they have made clear they need to see further progress in bringing inflation sustainably towards 2% before pivoting.

Canadian fixed income markets generated negative results last month, as the FTSE Canada Universe Bond Index declined 1.37%. After declining rapidly at the end of 2023, government bond yields reverted higher in January as investors recalibrated their monetary policy expectations in favor of a later pivot to interest rate cuts. The latest data portrayed a growth and inflation backdrop that is proving resilient, which led to some pushback on the idea that central banks are closing in on near-term rate cuts. At month-end, Federal Reserve Chair Powell reinforced this narrative and leaned heavily against the prospect for a March rate cut – which saw market odds for a rate cut that month fall.

The BoC kept the policy rate at 5% and reinforced their neutral stance. Dovish adjustments were made to their statement as they removed that they are “prepared to raise the policy rate further”. The clear message from Governor Macklem was that the BoC is more confident that policy is restrictive enough, but more time is needed to bring inflation down to target. Growth projections were lowered, but the year-end inflation forecast was only marginally lower at 2.4%. Rate cuts are not an urgency from the Bank’s point of view.

Bond yields have risen, primarily driven by shifts in longer-term interest rates. Yields have increased by up to 40 basis points in North America. These movements were the consequence of markets scaling back some of the aggressive expectations for interest rate cuts that had accumulated towards the end of last year.

CREDIT IN FOCUS

Credit markets took their cue from the favorable backdrop that propelled risk assets higher, such as equities. Credit spreads were narrow by 6 bps on the month and outperformed government bonds across all maturity segments, indicating sustained confidence in the credit quality of Canadian issuers. Despite uncertainties surrounding global economic conditions, investors continued to show resilience in their risk appetite for Canadian fixed income assets.

Provincial returns were negative given the back up in Canada yields, but spreads were narrower in mid- and long-term sectors. As budget season is upon us, British Columbia and Maritime provinces stood out as strong performers on the month.

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