Bonds poised to benefit from BoC and Fed easing

The Bank of Canada and U.S. Federal Reserve are expected to continue supporting growth with lower interests in the months to come, leading to a potential boon for fixed-income investors, says Adam Ditkofsky, senior portfolio manager, global fixed income at CIBC Asset Management.

Ditkofsky predicted three rate cuts from the BoC over the next 12 months, with the overnight rate reaching 1.75%. In the U.S., he’s expecting 125 basis points in additional cuts by the Fed, with the policy rate falling to 3%.

“This is good for bonds, as it implies lower yields, especially in the shorter-dated bonds,” he said in an Oct. 15 interview. “With yields being close to that 4% to 5%, investors should expect that that will be their returns over the medium to longer term going [in]to the bond market.” 

Listen to the full conversation on the Advisor To Go podcast, powered by CIBC Asset Management.

He said there are opportunities in shorter-dated bonds, including corporate bonds with maturities less than five years. He holds a modest overweight in corporate bonds versus government bonds, though at one of the lowest risk levels in recent years.

“This is really a reflection of the fact that valuations are stretched, with credit spreads being very tight relative to where they’ve been over the past few decades,” he said. “We aren’t calling for a recession. We continue to see credit outperform in the near term, but today, the average corporate index spread is close to 90 basis points, or 0.9% above the average government bond.”

Ditkofsky also predicted U.S. Treasuries will outperform Government of Canada bonds, especially those with 10- and 30-year maturities.

“We maintain an overweight in U.S. Treasuries relative to Canada within some of the portfolios that allow us to do that,” he said.

Ditkofsky’s high-yield exposure is near historic lows, focused on select outperformers. His portfolios are 100% currency hedged, with hedging costs around 1.25%, which he said is high by historical standards.

“We account for this when we’re looking at any foreign bond as well, especially any foreign corporate bond,” he said. “So even though we might be getting a higher yield in, say, a U.S.-dollar corporate bond or high yield, we have to account for this hedging cost as well.”

And Ditkofsky favours hybrid securities over high-yield. Hybrids, he said, are subordinated bonds from investment-grade companies that receive partial equity treatment.

“These issues, in some cases, offer larger spreads than higher-quality, traditional high-yield bonds,” he said. “And we believe that these offer better value in the current environment, as we’re getting some extra compensation.”

Bell Canada, Rogers, Enbridge, TC Energy and Brookfield Infrastructure Partners are some of the high-quality and well-known names in the investment-grade corporate bond space, he said.

Still, there are risks to the downside, Ditkofsky said, including the likelihood that spreads will widen.

“We aren’t trying to pick up pennies in front of a steam roller,” he said. “So it makes sense to remain somewhat defensive and maintain dry powder if spreads do widen, so we can take advantage of those opportunities.”

This article is part of the Advisor To Go program, sponsored by CIBC Asset Management. The article was written without input from the sponsor.