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October 21, 2021 | Paul Chapman
Transcript:
That's great. I'm here with the Founding Partner and President at Algonquin Capital Brian D'Costa. He's a member of the Bank of Canada Fixed Income Forum, and was the head of fixed income and rates for CIBC World Markets. So one of the thought leaders in the fixed income sector in Canada, and I'm honored to have you with me Brian. Thank you very much.
Thank you, Paul.
And I'll make this quick. So I think we'll kick it off with inflation, and the slight probability of stagflation at this point is very topical. So if you could give me your views on that, and then we'll take it from there.
Yeah, absolutely. And I think almost everyone has-- unless you're living under a rock, has noticed that the price of virtually everything has gone higher in the last few months, whether it's gasoline, your grocery bill.
And this is a reflection of the fact that with vaccines, the demand for goods and services has accelerated, whereas the suppliers had all cut back capacity during the pandemic, and we're having this mismatch of supply versus demand.
We do think that-- I do believe that in next year some time, we'll start to see the so constraints in supply ease, so inflation will slow. But I do think that we're in a world where inflation will likely persist a little above 2% as opposed to a little below 2%, which we saw in the last decade.
So with inflation running a little hot right now, and in your view we'll pull back a little bit, obviously the Fed thinks it's transitory but they're starting to change their tune somewhat on that, it's bigger than they thought, but what are the implications for interest rates there, on the back of that?
So we think it's very clear that interest rates are-- we're in a rising interest rate world. If we look back before the pandemic, we would call it-- we were in a 2% interest rate world, when inflation was about 1.8%. We think that as a minimum, we're going back to a 2% world, and we're-- call it, in a 1 and 1/4% world on average right now, so we do think there's a move that's going to come.
And if indeed inflation changes, to say a 2 and 1/4 world as opposed to 1.8, then we could be in a 2 and 1/2% to 2 and 3/4% interest rate world. And we think that will play out over the next 12 to 18 months.
So that all goes to say that fixed income investing has been traditionally, recently especially and I think moving forward, quite challenging. You know, we're seeing negative after tax real returns on many bonds. So pulling this all together, what does that mean for fixed income investing in your view?
Right. So we think it's a little bit of a bad news followed by potentially better news story. So the bad news is fixed income tends to do very poorly when interest rates are rising. We expect to see a number of bond funds with negative returns this year, and we think also next year.
The silver lining out of this is somewhere in the future, we'll probably get to bond funds that are yielding more than 2%, you know, you might be able to find for example. So we think you need to be in a corporate bond fund because at that point, you might be able to get 3% or 3 and 1/2 type yields, which after tax will probably keep you in line with inflation.
Unfortunately I don't believe that fixed income is going to be a very powerful return contributor to portfolios going forward. However, it'll have the impact of diversification, and potentially if equities-- if we're in a market where equities are declining, having some fixed income will provide a ballast in that world.
Yeah, it will be a challenging environment moving forward. I've written a number of times in my monthly notes, that it's going to be-- the return profile will be low and things will be at least lower than it's been, and things will be more challenging than they've been. But also and that brings the opportunities as well to work with great managers like yourself. So thank you very much. I appreciate having you with me.
Yeah, no. My pleasure Paul, thank you.
Thank you.
