January Outlook
January 12, 2023  |  By Hank Cunningham

The predominant belief among market participants is that inflation will decelerate rapidly, the Fed will stop hiking rates and there is a recession coming. Thus far, inflation has eased for three straight months, with the services component of CPI being the biggest contributor to still elevated inflation. For its part, the Fed, via different pronouncements, indicated that more hikes are to come, with the Fed Funds Rate going to at least 5%. It is likely, however, that hikes of only 25 basis points are in the cards. As to the recession, weakness is spreading in the economy, beyond what we’re seeing in housing. Manufacturing is weak and consumer confidence is sliding. Thus far, however, the employment market remains taut, with continued growth in non-farm payrolls, a lower unemployment rate and solid wage gains.

Last year was grueling for fixed income investors, the worst ever for performance. The coming year should witness a return to positive performance, perhaps in the range of 4% to 7%. This outlook is based on a peaking in central bank tightening plus steady improvement on the inflation front. To be sure, inflation remains in the forefront, and wage increases could limit improvement. Central bank rates will stay elevated with no easing likely in all of 2023.

The yield curve will remain inverted for the foreseeable future. In the meantime, fixed income investors will be able to earn 5% plus on short-duration bonds, thus producing positive returns with minimal risk to principal.

There are obstacles to this consensus forecast. Wage increases may continue to act as a floor on inflation. Fiscal stimulus from the U.S. will produce a total of $2 trillion dollars to be borrowed from the bond market. A third possibility is that energy inflation could surprise on the upside.

In summary, there will be more chapters in the bond market drama and we expect a wide trading range of 3.25% to 4.25% on the U.S 10-year Treasury bond.

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December Outlook
December 13, 2022  |  By Hank Cunningham 

There is a growing, almost unanimous, consensus that inflation has peaked and will fall rapidly, leading to more declines in bond yields. The lagged effect of this year’s seven increases in central bank lending rates has caused economic activity to ebb. Whether economies fall into recession is the big question and the answer is not yet clear.

It has been a grueling year for fixed income investors, one of the worst ever for performance. Next year should witness a return to positive performance, perhaps in the range of 4% to 6%. This outlook presumes a peaking in the central bank’s tightening, and steady progress on the inflation front. To be sure, inflation remains in the forefront; however, wage increases could limit its improvement.

Central bank rates will stay elevated with no easing likely in all of 2023. The yield curve will remain inverted for the foreseeable future. In the meantime, fixed income investors can earn 5% or more on short-duration bonds, thus producing positive returns with minimal risk to principal.

In summary, global credit markets are discounting the next rounds of interest rate hikes, which removes the surprise factor and should result in few knee-jerk reactions. It is possible that several central banks reduce their bloated balance sheets via bond sales. The corporate bond market is a good place to look for signals that monetary tightening is beginning to affect credit quality.

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November Outlook
November 17, 2022  |  By Hank Cunningham

Inflation remains a global issue, despite the recent improvement in North America. In Europe, consumer prices have accelerated above 11% with no sign of relief. There has also been extra turbulence caused by extraordinary developments in the UK. The U.S. Federal Reserve has quashed near-term enthusiasm that its interest rate hikes are near an end. Chair Powell has stated repeatedly that he would like to see several consecutive months of improved inflation numbers before considering a pause. Thus, the Fed Funds Rate is likely to rise 50 basis points on December 14. The Canadian bank rate will likely move up a similar amount on December 7.

As to market yields, the U.S. two-year yield, currently at 4.4%, could reach 5% with further tightening and the 10-year appears to be headed to 4.25% to 4.5%. There have been few signs of strain in credit markets, but vigilance is required. Given the extent of the bond market sell off, rallies from time to time are likely. It is possible we will see 3.5% on the 10-year Treasury.

The Bank of Canada has little choice but to follow the Fed as the Canadian economy has also proved to be resilient. In addition, the Canadian dollar has suffered at the hands of a strong U.S. dollar, although it has bounced from recent lows. The weaker loonie will nevertheless exacerbate inflation trends in Canada as import prices add to domestic cost pressures.

In summary, global credit markets are discounting the next rounds of interest rate hikes. This removes the surprise factor and should result in few knee-jerk reactions. There remains the possibility that several central banks may reduce their bloated balance sheets via bond sales.

The big question is: when will we see inflation turn? One month does not make a trend. While the cost of goods has shown weakness in recent months, the biggest component of the CPI is service costs, and they show little sign of slowing and may actually increase. There are signals of a recession on the horizon, but economic growth remains positives. Odds of such an outcome have grown, but a recession is by no means a certainty. Those who believe in the inevitability of a recession point to the lagged effect of monetary tightening and suggest it has yet to be felt, other than in the interest rate-sensitive housing market. It is important to watch the corporate bond market for signals that tightening is beginning to affect credit quality.

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