Fixed Income Monthly Monitor – January 2023
The FTSE Canada Universe Bond Index moved lower on the month, with a negative 1.65% return, this brings the 2022 performance to negative 11.69%. Here’s to hoping the worst of the bond rout is now in the rear-view mirror.
The Bank of Canada and the US Fed delivered their final rate hikes for 2022 and marked the most aggressive hiking campaign ever within a calendar year. However, it was overseas actions, notably the Bank of Japan, that cast yields higher over the last trading days of the month with their dovish nudge into the tightening camp as they formally widened their yield curve control targets.
Going into the final Bank announcement of the year, it was a coin flip between 25bps and 50bps. The Bank elected on the latter and the market barely budged. Was it the last hike of this cycle? Maybe. The Bank retained optionality as they move to data dependency going forward. The Bank will: “assess how tighter monetary policy is working to slow demand, how supply challenges are resolving, and how inflation and inflation expectations are responding.” We will soon learn if 400bps of rate increases over nine months is enough to tame inflation.
As is often the case with the Fed, it delivered on market expectations for a 50bps rate hike. The accompanying statement remained largely intact, with the notable phrase: “ongoing increases in the target range will be appropriate.” The Dot plot also moved higher with the median estimate for the Fed Funds rate at 5.0% to 5.25% at the end of 2023.
With the very front-end of the curve higher and short-term rates anchored by policy, the yield curve is significantly inverted on many fronts. In Canada and the US, the 2y/10y, 3m/10y and 5y/30y, etc., are all inverted, some deeply. The yield curve is sending a worrying message about the growth outlook in 2023.
Credit in Focus
Corporate bond spreads moved narrower along with a broader risk-asset rally over the month of December. Corporate bond spreads were in about 3 bps on the month and resulted in corporate bonds once again outperforming relative to governments across the curve. Higher quality corporate bonds (AA/A) outperformed in short- and mid-term sectors, while corporate BBB’s held in better in longer tenors. Canadian corporate bond full-year new issuances provided plenty of supply for the market to absorb and was only eclipsed by the record breaking 2021. Better valuations across sectors provides opportunity, however balance is required as elevated volatility is expected to persist.
Provincial bond spreads were modestly narrower on the month, with spreads outperforming in the mid-term section of the curve. This leaves mid- and long-term provincial spreads wider by 14 and 19 bps, respectively for the full year. Provincial returns topped corporates in the short- and mid-term sections, while underperforming in the long end over 2022.