Bonds poised to benefit from BoC and Fed easing

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Welcome to Advisor to Go, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject-matter experts themselves. 

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Adam Ditkofsky, senior portfolio manager, global fixed income at CIBC Asset Management 

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In terms of the inflation outlook, moving into the last few months of 2025 and looking into 2026, the biggest differentials between Canada and the U.S. remain tariffs on goods imported into the U.S. This has made it somewhat challenging for the U.S. and its ability to bring inflation back down to the Fed’s target of 2%. 

Currently, CPI is trending at just below 3% in the U.S., at 2.9%, which is in line with the core PCE Price Index, which represents the Fed’s preferred inflation measurement. But looking ahead, we still expect to see some of these pressures come down over the next few months. 

And this is really because we see service disinflation that continues to provide some of the offsetting relief, which should support further normalization of the inflation numbers in the U.S., albeit at a slower pace than what’s desired by the Fed. 

Now, there’s really two major tailwinds that we think provides support for this case, the first being ongoing relief in rental prices and increased vacancy rates. Rent is a major component in the CPI basket, and has continued to normalize post its peak in 2023. And the second being the improved slack in the labour force, which has reduced wage growth pressures, especially as job growth has come down in recent months. 

Now, as a point of reference, in 2022, there were two jobs available for every person looking for work in the U.S. Today, that number is normalized to less than one, and continues to trend down, further supporting the argument that wage pressures should continue to trend down. 

Overall, these factors should support further inflation easing, which is in line with our below-consensus view that core inflation should ease to 2.5% over the next 12 months. 

Now, in Canada we don’t have the same pressures in the U.S., given that the federal government has removed most of the counter tariffs that were put in place. But we continue to face economic weakness, with unemployment continuing to be elevated above 7% and with inflation continuing to ease, especially as rates have come down and reduced the burden on mortgage interest costs, which is directly included in the inflation numbers that we have here in Canada. 

So our expectation remains for Canadian inflation to average about 1.9% over the next four quarters. 

in terms of what this means for the bond market, it allows both the Fed and the Bank of Canada to focus on existing growth risks, which incorporates our view of sub-2% growth for both countries.  

This is really attributed to falling job creation. Now this supports the argument that both central banks will need to continue to cut policy rates over the next 12 months. And currently, we’re projecting three additional rate cuts for the Bank of Canada, with the overnight rate reaching 1.75%, and 125 basis points in additional cuts by the Fed, with the policy rate falling to 3%. 

Overall, we think this is good for bonds, as it implies lower yields, especially in the shorter-dated bonds. 

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In terms of positioning, we are currently modestly long duration within our portfolios. And this is consistent with our expectations for both the Bank of Canada and the Fed to continue to cut rates over the next 12 months — both views being slightly more than what is priced in the bond market today. 

Our expectations are also in line with the view that the yield curve could steepen. This would mean the move lower in shorter-dated bonds would be more pronounced than longer-dated bonds— though we think the opportunity is really in shorter-dated bonds as well. 

We also see opportunities for U.S. Treasuries to outperform Government of Canada bonds, particularly in the medium term, or on [the] longer end of the yield curve, so that’s 10-year and 30-year bonds, especially with a lot of cuts already being priced into the Canadian curve today. We maintain an overweight in U.S. Treasuries relative to Canada within some of the portfolios that allow us to do that. 

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In terms of positioning in government bonds versus corporate bonds, it really is mandate specific. Now, I’m responsible for active universe portfolios, which include both government bonds and corporate bonds. In my portfolios today, we still maintain a modest overweight in corporate bonds relative to our benchmark, but the exposure is close to its lowest level of risk in recent history. 

Corporate bonds represent about 25% of the entire Canadian universe. So if you look at my portfolios today, it would be roughly 50/50 depending on the portfolio — so 50% government bonds and 50% corporate bonds — but again, this is at some of the lowest levels of risk in the portfolio that we’ve had in recent decades. 

And 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. 

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 — and this is closer to the tighter end of our forecasted range. So it makes sense to be defensive in our portfolios. 

I’d also highlight, our high-yield exposure is also close to its lowest weight in recent history, with our focus really being on names that we think are going to outperform relative to the benchmark. I also would highlight that my portfolios are also 100% currency hedged, with the cost of that currency hedge being roughly around 1.25%, which is very high from historical standards. So we account for this when we’re looking at any foreign bond as well, especially any foreign corporate bond. 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. So that’s something that we’re looking at very carefully as well when we’re making investment decisions. 

But really the overall message I would articulate is that we are being very defensive with our corporate position. 

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In terms of sectors offering good value at the moment, it’s hard to look at credit, or any risk asset really, without saying spreads or valuations don’t look expensive. But this is a similar story to equities, where valuations also seem stretched. It doesn’t mean we’re expecting an imminent pullback.  We aren’t calling for that, especially since central banks are expected to continue to ease over the coming months. In our view, spreads or credit can stay at these levels for some time, which means that corporate bonds could continue to outperform. 

And from a fixed-income perspective, credit investors continue to do well in scenarios where spreads remain sideways, especially as they continue to benefit from yield carry. And from a historical basis, all-in corporate yields still look very attractive. 

But again, we can’t ignore valuations. It’s fair to say downside risks, or the next major move is likely going to be wider spreads, as opposed to drastically tighter spreads. So from our perspective, it makes sense to be focused on shorter-dated credit, meaning corporate bonds with maturities less than five years. 

Our focus right now is to be overweight short-term corporate bonds, and underweight long corporate credit. 

We are also neutral in the midterm bonds, so call that 10-year bonds. But we’re focusing here on bottom-up analysis. So anything that we think that makes sense or looks cheap, we’ll take advantage of that. But again, our real focus right now where our overweights are, where we see the most value, or the best opportunities are really in the front-end or in shorter-dated corporate bonds. 

We also prefer hybrid securities over high-yield bonds. Hybrids represent subordinated bonds issued by investment-grade corporations that also benefit from issuing these hybrids because they get some equity treatment as part of their issuance. 

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

So some names in this space include Bell Canada, Rogers, Enbridge, TC Energy, Brookfield Infrastructure Partners — all of them being high-quality and well-known names in the investment-grade corporate bond universe. 

Overall, though, we remain defensive in the portfolios, so we’re still focusing on higher quality. But again, we can’t ignore that the risks are to the downside, and we aren’t trying to pick up pennies in front of a steam roller. So it makes sense to remain somewhat defensive and maintain dry powder if spreads do widen, so we can take advantage of those opportunities. 

Given there’s plenty of noise, especially around tariffs, we think this is a prudent strategy. 

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We still think now is a very attractive time to be going into the bond market. 

One, over the medium term, the returns that the investors tend to get in the bond market tend to be what the overall yields are that they’re getting in the portfolio. Now, 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. 

Additionally, the bond market now — given the fact that yields are higher and that we have central banks that are focused on supporting growth and are less focused on the inflation aspect — we think that the bond market today offers that balanced portfolio appropriate protections, meaning that in risk-off periods, bond yields will fall, and they will offer to those investors that protection when they see their risk assets come off a little bit or if they see a sell off. 

We can’t ignore the fact that equity markets are stretched at the moment, in terms of their valuations. And while they can move sideways for some time or continue to move higher, there are, of course, material risks to the downside, because all it could take at this point, especially with the noise with tariffs right now, is one tweet, and we can see the risk market sell off very quickly. 

So it makes sense to be balanced in a portfolio, and having bonds in a portfolio to add that diversification that they historically have provided. 

So we’d say that the 60/40 portfolio is very much alive and well from that standpoint, because bonds, again, do provide that protection, and we’re not in a situation where central banks are hiking rates. They’re more in a focus on maintaining stability in the markets, and they’re more in a rate-cutting cycle. 

So we think today makes sense to be buying bonds.

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