Volatility makes corporate bonds attractive

With the BoC holding the key rate at 0.5%, managers aren’t modifying allocations.

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“We’ve known this was coming, so it doesn’t change our outlook,” says Patrick O’Toole, vice-president of global fixed income at CIBC Asset Management and co-manager of the Renaissance Canadian Bond Fund, an underlying fund in the Renaissance Optimal Income Portfolios.

What’s more, he says, “No change in the bank rate is expected in the next 12-month period. The [futures] markets have got that priced in, and that’s our view as well.”

He expects the main drivers of bond yields to be “global events and U.S. growth” over the next year. As a result, “corporate bonds are going to continue to be the vehicle of choice for investors.” And now’s an opportune time to buy: “They’ve been under pressure over the last several months, as we’ve seen volatility caused by uncertainty about the U.S. recovery and China. The result has been wider credit spreads.”

Over the next 12 months, he says, those spreads won’t compress by much. And, “the extra yield you’re getting on corporate bonds makes them fairly attractive at the present time, both for investment-grade and the high-yield sectors. We’re expecting those sectors to outperform Government of Canada bonds in the next year” so they’re overweight in his portfolios.

Read: When to question bond credit ratings

Lessons from the Monetary Policy Report

The BoC made several assumptions in its Monetary Policy Report (MPR):

• The Canadian dollar will remain at 76 cents U.S.
• Gasoline price margins will return to average in Q1 2016, and oil prices will remain close to recent levels.
• Total CPI inflation is expected to remain below 2% until the beginning of 2017.

O’Toole says those assumptions “are more in keeping with what you’re seeing from the broader economic community.”

Regarding the loonie, “The Bank of Canada knows [the dollar has] had a 20% decline over the last year. We’re actually seeing a good surge in exports for currency-sensitive sectors of the economy,” he says.

Read: BoC maintains overnight rate, lowers growth forecast

The MPR notes “travel services have been particularly robust, supported by the lower Canadian dollar. The number of international visitors to Canada has picked up, while the number of Canadians going abroad has declined noticeably.”

But, says O’Toole, “Canada isn’t the only one with a weaker currency vis-à-vis the U.S. So, we’re not likely to get as strong a boost to our export sector as we’ve seen in past episodes where the CAD has gone down. We’re competing against other countries that are trying to push goods into the U.S. also.”

As far as gasoline prices, he says, “there’s some hope for Canadians.” The recent decline in oil prices “hasn’t been met by as much of a decline in gasoline prices, like we normally would see.” O’Toole says that fortunately, the MPR shows the BoC “expects that relationship to re-assert itself. We’ll see gasoline prices move lower, and that will help keep the overall CPI rate lower than the midpoint of the BoC’s target.”

And there’s more good news. “There’s potentially some upside to their forecast, as opposed to the downside we’ve seen, given the results of the federal election this week.” O’Toole points to the Liberal party’s promise to spend $10 billion annually over the next three years. “That could give a boost to growth of about as much as half a percent [GDP],” he says, adding the CAD could also benefit, and that inflation may also rise slightly. “In the next Monetary Policy Report, or the one following that, we may see the BoC upgrade their expectations somewhat.”

Read: Understand duration for better bond returns

As for global influences, he says the BoC sees “the potential for U.S. growth to do better,” but concedes he “may not be as optimistic as they are.” He also agrees with the BoC’s statement that concerns about China may be overblown.

Melissa Shin

Melissa is the editorial director of Advisor.ca and leads Newcom Media Inc.’s group of financial publications. She has been with the team since 2011 and been recognized by PMAC and CFA Society Toronto for her reporting. Reach her at mshin@newcom.ca. You may also call or text 416-847-8038 to provide a confidential tip.