Fixed Income Monthly Monitor – February 2023

Market Update

The FTSE Canada Universe Bond Index delivered 3.09% return in January as the interest rate cycle transitions to the next phase of its journey. Last January, the year commenced with a thumping negative 3.4% return as the hiking campaign was simply lip service at that point. The worst of the bond rout has likely past after one of the most aggressive rate hike cycles, but uncertainty remains, which means more volatility is likely ahead. A notable bright spot is as the 12-month return figures drop a very negative January 2022 for a very positive January 2023 print, one-year return figures improved from a double-digit loss to a mid-single digit loss. Bonds are regaining favour with investors. 

After a year of markets honing in on the level of the Bank of Canada’s terminal policy rate, it may now be realized. Maybe. The Bank delivered another 25bps rate hike and clearly communicated their intention to pause, conditional on economic developments evolving in line with their current outlook. The Bank indicated they will now assess the economic impact and inflationary trends given the cumulative rate hikes that are expected to continue to filter through to the real economy. However, The Governor specified that if inflation does not revert to the mid-point of their 1% to 3% target range with confidence, they are prepared to do more. 

U.S. Federal Reserve also delivered a 25bps rate hike on February 1st (January plus a day). The downshifted hike was consensus, statement language was largely unchanged, but Powell’s press conference was viewed as dovish resulting in falling rates and roaring risk assets. The likely cause was Powell’s lack of pushback against the recent easing in financial conditions and his comments proclaiming that the disinflationary trend has begun. The reality is the Fed has more rate hikes ahead and the market dislocation between expectations and policy actions is likely to converge over time. 

Credit in Focus

Corporate credit was on fire. Credit spreads moved narrower by 12bps on the month. Similar to the rates market, it was a mirror image of last January. The broader risk-rally was indicative of strong technicals, as sidelined cash was put to work. Corporate yields above 5% at start of year seemed to have brought investors back into bonds. The strong spread performance was despite a wave of new corporate issuance, which was handedly absorbed by the market. 

Provincial bond spreads were modestly narrower on the month but supported the strong performance across the sector alongside the fall in Government of Canada yields. Provincial spreads performed best in short- and mid-term tenors with consistent narrowing across all issuers. Alberta modestly lagged, but has outperformed over the past year, even as oil price momentum as waned recently. 

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