Long-term interest rates will remain stable

The credit environment for fixed income in Canada continues to evolve.

We’re currently in a very low interest rate environment that’s causing some challenges. However, we’re also seeing incredible demand for bonds from clients who have shifted away from the changing equity markets of the last ten or fifteen years.

“The Lehman story is still fresh in people’s minds and they’re continually looking to de-risk,” says Patrick O’Toole, vice-president of global fixed income at CIBC Asset Management. “Investors are looking to get paid more on their investments and have moved away from focusing on growth and more turbo-type investments and returns.”

Overall, investors have moderated return expectations and have set a good, underlying tone in the fixed income market in Canada. During the past couple of years, economists have predicted an upcoming bear market in bonds and even gone so far as to predict that bonds are finished. He contends this is a faulty scenario.

Institutions may raise interest in the next two to three years, but longer-term interest rates will be stable and lower than expected. While interest rate have come down in the last twenty or thirty years, we are currently trading in a sideways pattern as we continue to go through the pain of the deleveraging process.

Expect to see low rates from the central banks, which will be the order of the day for Canada, the U.S., developed countries and the Eurozone. The Bank of Canada could hike interest rates soon, but won’t do so in the coming year.

“Canada, in particular, is enjoying a sound fiscal policy that’s helping to underpin lower interest rates,” says O’Toole. “There’s also good foreign interest in Canada due to these policies and due to our credible central bank.”

He adds, “Together, these factors have kept a lid on any upward pressure on long-term interest rates.”

The last few months, we’ve seen improved economic data and did see a spike in bond yields. Current headlines have propelled fears about an imminent bear market in bonds, but we tell clients not to panic when things are looking down. When markets take a turn, governments and central banks will always come in with stimulus measures to keep the economy going.

Conversely, don’t follow trends when things are going well. O’Toole says, “Especially in today’s market, it’s hard to tell how long a positive streak will last due to the continued force of deleveraging weighing down growth. We’re not surprised to see growth look good for the odd quarter and then give way in the next quarter to a softer trend path.”

The recovery will likely be sluggish and uneven, with growth in the 2%-to-2.5% zone. It’s far from dire and it’s what people should base their expectations on going forward for the next decade.

We also have a demographic factor affecting GDP levels, baby boomers are getting older and 10,000 of them are retiring every day. This situation is currently affecting government bond yields as well.