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Why bond yields are likely to stay low

November 14, 2017
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Bond yields are likely to remain low in light of the Bank of Canada’s wait-and-see-approach in its October interest rate decision, says CIBC Asset Management Inc.’s Patrick O’Toole.

After two consecutive rate hikes, the Bank of Canada maintained the overnight rate at one per cent on Oct. 25, citing uncertainty around North American Free Trade Agreement renegotiations and expectations that the Canadian dollar’s strength would slow inflation. As of Nov. 10, the loonie was sitting close to US$0.79, only slightly down from its fall peak of about US$0.82.

“For about every three cents of appreciation of the Canadian dollar, that’s equivalent to about 100 basis points or a whole percentage point of a hike by the Bank of Canada,” says O’Toole, vice-president of global fixed income at CIBC Asset Management.

Read: Oil price rebound helps DB plans achieve sixth straight quarter of growth

The Canadian dollar was at US$.078 when the bank made its most recent rate decision, presenting a potential headwind for the Canadian economy, says O’Toole. The bank likely wanted to see the implications of those headwinds before raising the lending rate again, he adds.

For Canada, O’Toole predicts growth of around two per cent for the next 12 months. That’s in line with the bank’s forecast that inflation would rise to two per cent in the second half of 2018.

Even if, in the longer term, central banks around the world gradually move to raise interest rates to more normal levels, O’Toole says bonds yields should remain low.

On Oct. 26, the European Central Bank said that while it would ease the pace of its bond-buying stimulus program, it would continue its purchases until at least September 2018. In Britain, where inflation is closer to three per cent and nearly double that of the European Union, the Bank of England raised interest rates for the first time in a decade on Nov. 2. It said the effect would be modest, however.

Read: DB plans see boost from Canadian equities amid modest performance in third quarter

While the longer-term return to normal interest rates could affect bond yields, O’Toole says it won’t change the mix of government and corporate bonds in his portfolio.

“We’ve been of the view these last several years [that] corporate bonds were going to win the day and that has been the case,” he says. “The economy’s been OK, the back drop is constructive for economic growth, and that follows through to corporate bonds. They generally outperform government bonds when that’s happening. In particular, it tends to happen as interest rates do rise also.”

Canada’s growth may be slowing to more moderate levels after a hot first half of 2017, but O’Toole hasn’t changed the outlook for his portfolio. “We continue to think that yields could move a little bit higher, but it’s not going to be anything too dramatic given growth is reverting back pretty much close to trend levels,” he says.

This article first appeared on the website of Benefits Canada‘s companion publication, Advisor.ca. Listen to the full podcast on AdvisorToGo.

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