Fixed Income Monthly Monitor – October 2022

Market Update

The FTSE Canada Universe Bond Index pulled back on the month, with a negative 0.53% return. As volatility in global government yields pick-up, with longer term UK Gilts swinging wildly within the span of a few trading days and the US 10-year Treasury pushing towards 4%, mid- and long-term Canadian yields were relatively tame by comparison. The Canada 10-year yield ended the month at 3.17%, moving up 5bps and opening a notable spread between its US counterpart. This is perhaps a notable inflection point where domestic fundamentals, including high Canadian household debt and an elevated sensitivity to higher rates, may influence market pricing differentials. Notable movements occurred at the front of the Canadian yield curve, with 2-year yields priced higher on recast expectations for the terminal rate. 

The Bank of Canada and the Federal Reserve both delivered a 75bps hike on the month, with cumulative rate hikes of 300bps over a six-month span. The policy rates now sit in what has been characterized as restrictive territory at 3.25%. 

Central bankers are playing catch up to persistent inflation and a realization they need to reign in demand to contain price and wage pressures. Their rhetoric suggests they are willing to endure (inflict?) pain to re-establish medium term price stability and maintain creditability as an inflation fighter. The curve inversion is an indication that markets expect they will be successful, but with terminal rates remaining higher than pre-pandemic levels. 

Bond markets remain exceptionally volatile. We cannot rule out further upward pressure on yields and spreads, but some leading indicators are showing tighter financial conditions are beginning to bite. Given the lagged impact of policy tightening, we may be approaching a period when bond markets are somewhat more range bound awaiting evidence that inflation pressures are indeed moderating. If that is the case, the all-in yield on bonds will prove attractive. 

Credit in Focus

After performing relatively well through the summer months, Canadian credit spreads widened by about 15 bps, on average, with no sector spared. Corporate bonds underperformed Governments across the curve with Telecom, Pipelines, Insurers and REITs as notable underperformers on the month. 

Provincial bond spreads moved opposite corporates, with spreads narrower across the front-end of the curve, while longer tenors were modestly, 1-3 bps, wider. This reflects the up-in-quality trade that characterized the market during the September risk-off episode as Central Bankers reasserted their intention to keep on hiking policy rates until their confident price stability will be restored. 

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