Fixed Income Market Winning Streak

For only the third time in 3 years, North American fixed income markets enjoyed a 3-month winning streak in July, the first of 2024!! In case you were wondering, Q4, 2023 and April – July 2021 were the others. Concerns over a faster and more acute slowing of the US economy caused investors to accelerate their rate cut expectations. This helped to push down longer-term bonds yields. Notably, contrary to recent market behaviour where “bad” news about the economy, was “good” news for risk markets given the increased likelihood of monetary easing, July saw the return of “bad” news is “bad” news for risk assets and bonds acting like a ballast in a balanced portfolio. On the month, the Canadian Universe Bond index was up 2.4% (Chart 1), pushing its 3-month and YTD returns to 5.4% and 2.0%, respectively. Just past the halfway mark, it is not yet the “year of the bond” that many had expected in 2024, but since May the market has enjoyed one of the best 3-month stretches in recent years. Similarly, the aggregate US bond market rose 2.3% MoM, with a 3-month pop of 5.1%, and improving its 2024 performance to1.8% (Table 1). Even with the recent decline in yields, investors continuing to benefit from historically attractive yield levels with the aggregate Canadian and US bond markets yielding ~3.8% and 4.7%, respectively. Despite an intramonth selloff that saw the S&P 500 fall 4.7%, risk assets broadly recovered to post another solid month of total returns. The S&P 500 rose ~1.2% on the month and is up ~16.6% YTD, while the Dow Jones Industrial Average gained ~4.5% MoM and is up 9.5% YTD. The Nasdaq composite fell ~0.7% in July, but has still posted a 17.7% YTD, The S&P/TSX made up ground on its US counterparts, rising ~5.9% on the month, bringing its YTD return up to ~12.2%.

Chart 1:

Source: FTSE/Russell; Bloomberg

Over the month, YTD and 1-year, Canadian Federal bonds returned +2.05%, 1.51% and +6.10%, respectively, while the overall Universe Bond Index returned +2.37%%, 1.99% and +7.34%, respectively. Corporate bonds performed inline with their government counterparts, returning +2.23% on the month. Yet with returns of +3.41% YTD and +9.23% over the past year, Canadian investment-grade corporate bonds have far outpaced government debt. Provincial bonds rose 2.62% on the month and have returned 1.08% YTD and +6.84% over the past year – outperforming on the month due to their longer average term-to-maturity in a falling yield environment. Conversely, YTD the rise in bond yields and steeper yield curve have been a relative headwind for provincial debt.

Rates Markets

With the Federal Reserve in self-described “data dependency” mode, the Rates markets have jumped from one highly anticipated data point to the next in quick succession. This has led to increased investor uncertainty and elevated levels of day-to-day, and even intraday, volatility in yields. In addition to the usual data calendar, August also brings with it the US central bank’s annual pilgrimage to Jackson Hole, Wyoming. While more often than not these meetings prove to have little impact on markets they have been used on occasion by central bankers to signal something of importance to investors. This year, with markets fully expecting the Fed’s first rate cut in September, weaker than expected economic data of late and heightened market fragility, Chairman Powell’s address will be keenly watched. Here are a few things to keep an eye on in his messaging:

• The Fed’s level of confidence on a sustainable path to lower inflation.
• Characterizations on the state of the labour market.
• The FOMC’s views on the balance of risks to their dual inflation and full employment mandate, i.e. how much have the risks shifted from inflation fears to worries about the jobs and recession.
• Will the central bank substantiate the market’s expectations for the path of policy rates or will they try to influence them in a different direction in terms of timing and magnitude of future rate cuts.

We will provide a recap of the Jackson Hole meetings in next month’s commentary.

MoM Rates Market Snapshot:

• Larger rate cut expectations.
• Lower longer-term yields.
• Steeper yield curve.

Rates positioning: (i) Neutral duration; (ii) yield curve neutral; (iii) overweight Cdn prime residential mortgages; (iv) overweight RRBs; (v) overweight USTs.

Credit Markets

While the concerns surrounding the US economy and the intramonth volatility in equity markets had some minor spillover into credit markets, valuations ended little changed on the month. There has been some widening pressure on credit spreads in the first half of August, the magnitude again has been rather muted. Historically, these periods of small spread widening have proven to be attractive periods to add corporate exposures.

MoM Credit Market Snapshot:

• Credit spreads very slightly tighter in July.
• Returns in line with government bonds on the month, but YTD excess return have been substantial.
• Higher quality has outperformed recently.

Credit positioning: (i) overweight credit; (ii) maintain a quality bias in favour of IG over HY, and more defensive credits within IG; (iii) overweight Cdn corporates, underweight US.