Inflation is coming down, that’s clear. What’s in focus now is the level at which it ultimately settles. Do we return to a period like the previous decade where inflation is tame and often considered an afterthought for investors? Or have secular trends and forces (demographics, onshoring, fiscal stimulus, etc.)  catalyzed a new regime of higher inflation? The purpose of this note is not to postulate where inflation is heading, but to acknowledge the ongoing debate as well as what comes with it; bond market volatility. Interest rates have been anything but stable recently and, following the latest increase, we see an attractive entry point for fixed income investors.

 

The Government of Canada 10-year yield is nearly back to 3.5%. Not particularly attractive for those seeking yield, but worth noting its close to a 10-year high.  

 

Canada 10-year bond yield

Source: FactSet

 

Corporate bond spreads (the additional yield beyond Government of Canada bond yields) have declined a bit but remain well above their long-term averages. This suggests that the extra compensation for assuming corporate risk is reasonable, if not outright attractive.  

 

Canada corporate bond spread

Source: FactSet

 

We currently own and are adding to the following corporate bond issues. They yield nearly 5% on average which is attractive in any account, but what we find most exciting is their tax effectiveness for non-registered portfolios (held outside a TFSA, RSP, RIF, etc.). Because these bonds trade below par (the maturity value, $100), a portion of their return will come from capital gains which is more tax friendly than interest. The result is a taxable equivalent yield of 6.68%, on average, which means you would need to purchase a GIC that yields 6.68% in order to achieve the same after-tax return (assuming the top marginal tax rate). 5-year GIC rates are currently around 4.50%.

 

 

If you have any questions, please do not hesitate to reach out to anyone on our team.