After last year’s multiple interest rate cuts, we’ve been experiencing historically low yields for more than 12 months, which has had a significant impact on our collective desire to own bonds, GICs and other types of fixed-income. However the decline in interest rates didn’t just start in 2020. If we look back, the (surprise) cuts started happening in 2015 and as such, it has been difficult to own much in this area for over 6 years. This has led to a movement away from interest-bearing vehicles in favour of equities.

We’ve also seen that a portfolio more heavily weighted to “stocks” has the added benefit of inflation protection. In theory, equities offer more upside potential and have historically demonstrated an ability to generate returns that exceed inflation.

There is no doubt in my mind that this trend has proven to be beneficial in terms of overall portfolio performance. But there is a caveat here… we know from experience that a higher concentration of equities can also lead to greater volatility, which in turn can make it harder for investors to remain calm and stay invested.

Given the rapid movement in bond yields over this past week, I thought it would be helpful to look at what is happening:

• The recent steepening of the yield curve has resulted in the 10-year bond yield at its highest level in over a year, while the front end of the curve remains anchored by short term policy rates.
• Based on current pricing, the market expects the Fed to begin hiking interest rates sometime in the second half of 2022, which is two years sooner than what expectations were in December.
• RBC believes that expectations for an aggressive hiking cycle are misplaced. Upticks in inflation expected around the middle of this year are likely to be transitory while the economy’s recovery from COVID-19 will stretch over several years. These factors will lead to a cautious hiking cycle from policymakers when it does occur.
• Overall, RBC doesn’t expect a significant change in bond yields from current levels. Central banks are likely to be slow to raise interest rates, which will keep bond yields range bound over the coming year. While returns for long sovereign bonds have been hit the hardest this year, other sectors of the fixed income market have done well (think preferred shares), highlighting the benefit of diversification.

If you have questions regarding how fixed income fits into your portfolio, please feel free to reach out.

Libby

 

 

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