Fixed Income Monthly Monitor – July 2022
The FTSE Canada Universe Bond Index returned negative 2.18% on the month. Yields were higher, across the Government of Canada curve, with 10-year yields higher by 33 bps and the curve flattened (shorter term rates raised by more than longer term rates).
The Bank of Canada delivered a 50 bps hike on the month and signaled more to come to get the overnight rate into their “neutral range” (2% to 3%) “expeditiously”. The US Fed upped the ante with a 75 bps rate hike mid-month, as Chair Powell cited a resilient economy as a reason for the upsized hike after originally guiding the market to expect 50 bps.
The persistent strength of inflation, and the policy response deemed necessary to address it, is causing concerns for growth and lowering market participant’s probability for a “soft-landing”. Central bankers are clearly transitioning to a more aggressive phase of the global tightening cycle. Markets have taken notice and are doing a lot of the tightening for central banks – yields higher, credit spreads wider, yield curve flatter, equity markets lower and housing market softening.
The economic overhang is clearly the uncertainty on the future path of inflation and how much (or little) monetary tightening will be required. Inflation was allowed to gain traction by tolerant central bankers that now find themselves behind the curve and in need of cooling demand. This has brought into question their creditability as inflation targeting institutions. They now find themselves in a situation where they will be forced to continue monetary tightening as the economic backdrop weakens and financial markets wane. This approach will either result in inflation moving down to more tolerable levels and towards their targets or they will be required to tighten even more aggressively than is currently priced in to restore price stability. The latter is certainly concerning.
Credit in Focus
Canadian credit spreads widened a modest 2 bps, on average, bringing the YTD widening to 54bps. Corporate bonds outperformed government bonds owing to the improving carry advantage, offsetting the widening momentum. Risk-assets were under pressure for most of the month as recession fears mount. Technicals have been supportive. A deteriorating market backdrop has kept potential issuers sidelined and, not surprisingly, has resulted in the slowest June issuances since 2013. YTD new issuance supply is lagging last year’s record pace by about 7%.
Provincial were underperformers across all maturity segments with spreads wider by 2-5 bps in mid- and long-term maturities as market risk appetite deteriorated. Alberta continues to lead as their fiscal position has improved and is the only province over the past 6-months where longer term spreads have compressed.