Fixed Income Monthly Monitor – September 2023

MARKET UPDATE

Canadian fixed income returns were negative in August, with the FTSE Canada Universe Bond Index posting a 0.2% decline for the month. Bond yields marched higher, but finished the month below their peaks with the Canada 10- and 30-year yields up 6 and 8 bps, respectively. Canada 2- and 5-year yields finished unchanged. This resulted in a bear-steepener, consistent with a market that views elevated inflation as sticky and the necessity for central banks to maintain high policy rates for longer. 

After a strong start to 2023, the Canadian economy appears to be slowing under the weight of high borrowing costs. The Canadian economy contracted by 0.2% in Q2, well below the Bank of Canada and markets expectations. The slight contraction is consistent with coming data, such as the 0.5% rise in unemployment, decrease in job vacancies, slow down in housing, etc. Weakness has been broad based across both service-producing and goods-producing industries. The Bank has historically relied on GDP as a key input into their policy decision-making framework. With the Bank in data dependent mode further rate hikes will be harder to justify. 

All eyes on Jackson Hole. Chair Powell offered little in the way of new information and reiterated that monetary policy would return inflation to target. Powell acknowledge that tighter policy was putting pressure on broader growth, however contended that risks to better-than-expected growth could result in the necessity for further tightening. Like Canada, terminal is likely in sight with the higher for longer policy theme in place south of the border as well. 

CREDIT IN FOCUS

Corporate bonds were the best performing sector given the short duration profile. Spreads moved wider 4 bps, on average, and resulted in corporates underperforming all governments in short- and mid-term segments. Communication sector was the clear laggard on the month with spreads moving out on a supply overhang. 

The back-up in Government of Canada rates and widening spreads in longer term segments of the provincial market resulted in a negative performance for provincials on the month. Spreads were wider in both mid- and long-term maturities, whereas spreads in short bonds were in about 3 bps on average. Provincial spreads are only modestly different versus start of year levels, but have outperformed Canada’s YTD. 

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