Positive momentum builds in bond markets

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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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Gino Di Censo, director, global fixed income at CIBC Asset Management 

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So there have been a few key drivers lately on bond market performance. I’d say one is the expectation of further rate cuts by both the Federal Reserve in the U.S. and the Bank of Canada. I’d say secondly and thirdly are strong technicals and fundamentals, which have generally been driving bond market performance.  

So, I’ll expand on the technical comments. So really on the technical side, there’s been not enough net new issuance to satisfy demand in the credit markets, which has been supportive of prices. And then on the fundamental side, fundamentals have been constructive and been fairly resilient.  

So I’d say earnings outlooks and forecasts have been reasonably positive with the underlying companies. And the underlying companies have generally been overall healthy. So these have all led to really positive bond market performance over the past years thus far to the beginning of September. 

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In terms of expectation for future rate cuts, CIBC Asset Management’s base case as of the most recent Q2 forecast was 100 basis points by the Fed in the U.S., and 50 basis points by the Bank of Canada over the next 12 months. I’d caution to say that this is our most recent forecast as of the second quarter, [and] that we do come out with new forecasts and revisions every quarter, so this could change.  

And really, what this means for bond markets going forward is that this should be supportive of bond market performance. Of course, I’d say that there is risk to the downside should these expected cuts not materialize in the market.  

Our outlook over the next 12 months with respect to inflation is that we expect it to remain elevated, but close to the Bank of Canada’s target. And I think this, coupled with a weakening economy, should give [the] central bank leeway to cut rates to support the potential deteriorating economic conditions. 

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Broadly speaking, in terms of where we see the best opportunities in fixed income, I would say high-quality bonds continue to remain very attractive. You can obtain solid income without taking undue credit risk. I would also add that we like corporate hybrids over high-yield bonds, as you’re getting yield pick up for less credit risk. Of course, we do have high-yield exposure in the fixed-income funds that allow for it.  

With respect to our fixed-income pools, just to highlight some positioning changes there, we continue to be in a more defensive stance as at [the] beginning of September, with duration slightly longer than we’ve had it versus the prior quarter. And this is really in anticipation of seeing lower yields, partially attributed to some fear surrounding tariffs in the market and market pricing in additional rate cuts. So we think taking some additional risk with duration can make sense in the current market environment. 

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Certainly, there are a few things that are keeping us up at night as bond investors. Let’s say, you know, the escalating volatility with respect to policy shocks or in macroeconomic uncertainty, as well as the political instability we’re seeing in major economies, such as Europe currently, could fuel the bond market volatility further. 

Valuations, with respect to corporate bonds, have and remain very rich. But I’d say this has been supported by technical and fundamentals, as I had mentioned earlier. But, the risk here is that should the fundamentals or technical start to deteriorate in the bond market, this will put pressure on bond prices. And we don’t think the risks seem to be fully appreciated by the markets at this time. 

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We continue to like Canadian bonds for sure. We think that yields remain very attractive, as I mentioned. I’d say we are expecting a few more rate cuts in the U.S. than in Canada. And this should be supportive of U.S. bonds for sure. And then globally, we think the yields look very attractive on a global basis, and we think there are certainly compelling opportunities across global bonds.  

And we have been allocating where our funds permit the ability to do so. What I would say, and I’m just referencing back to the political volatility I mentioned earlier, is we do expect potentially a bit more volatility on the global bond market if political instability continues. 

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We do believe that bonds are regaining the traditional role as a hedge against equity market volatility. You know, if you look back historically, you know with the exception of 2022, when we saw rapid rise in rates, which caused a negative impact on bond prices in addition to equity markets, beyond 2022, though, we generally see a negative correlation between equity and bond prices, which means when equity prices are declining, generally bond prices are positive. 

And so that’s historically why they’ve been a ballast in the portfolio. And we’ve seen that continue, as I’ve said, beyond the 2022 period with 2023 and 2024, with bonds returning back to how they’ve been performing historically against equity markets. So, yes, we definitely think bonds continue to be a key ballast in the portfolio and believe they will remain a core part of traditional 60-40 portfolio. 

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A takeaway for me here is that bonds continue to provide the two key pillars in the portfolio, income and protection of principle, and why we like them as a core part of client portfolios. And I think, you know, important now more than ever, is to find a manager with a disciplined process that can successfully allocate across different components of the fixed-income market, as required.  

And, you know, we’ve seen various components perform better and worse at different times, and so we appreciate being dynamic and being ready to take advantage of any opportunity should fundamentals deteriorate and credit spreads widen, which will allow an attractive entry point for our fixed-income managers.  

Overall, our outlook is constructive. We think the spreads and valuations are certainly rich, but we, as mentioned, see positive fundamentals and technicals, which we believe are going to be supportive of bond markets going forward. 

That being said, we continue to maintain a defensive stance in our portfolios because of the underlying risks, which we are keeping an eye on, as I mentioned earlier. So overall, I’d say we are constructive and positive on bond markets going forward, but we are keeping an eye on some of the macroeconomic risks in our portfolios. And certainly as bond investors, it’s important that we do keep an eye on those items.

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