March Outlook
March 14, 2024 | By Hank Cunningham
Economists are preoccupied with what kind of “landing” the U.S. economy will experience: will it be hard, soft or nonexistent? Too much time has been spent forecasting the next recession. Meanwhile, the economy, seemingly ignoring the Fed’s monetary stance, is growing at a 3% pace.
There will be no change in the monetary stance in the U.S. or Canada in the near term. While the Fed has stated that three rate reductions are possible this year, the timing of those has been pushed out. The recent CPI reports underscore inflation’s tenacity, meaning a rate reduction could be counterproductive to the Fed’s fight. What is more probable is a gradual move to lower rates with the Fed Funds rate possibly moving 50 to 75 basis points lower towards the end of the year.
A similar scenario is unfolding in Canada after GDP growth picked up towards the end of 2023, putting the Bank of Canada on the sidelines, and reiterating its cautious stance at its recent deliberations.
Another important factor is the increasing likelihood that the Bank of Japan will tighten its monetary policy and that could lead Japanese investors to sell their U.S. Treasury bonds.
Inflation remains the key fundamental for the bond market outlook. With the recent economic strength, accompanied by escalating wages, it will likely prove difficult for inflation to reach the avowed 2% target level. Should that prove to be the case, then it stands to reason that longer-term bond yields should rise from current levels. This also reflects the massive borrowing requirements as there is no attempt to rein in federal deficits. In addition, the Federal Reserve is still engaged in quantitative tightening (QT). The Bank of Canada is also continuing its QT. The net effect ultimately will be an eventual return to a positive yield curve, with short- and mid-term yields likely falling below longer-term yields. Still, the normalization of the yield curve probably won’t happen until the latter part of the year.
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February Outlook
February 13, 2023 | By Hank Cunningham
The resilience of the U.S. economy has prompted the FOMC to maintain its monetary stance for now. While it has stated that three rate reductions are possible this year, the timing of those has been pushed out. The recent CPI report underscores inflation’s stickiness, meaning a rate reduction could be counterproductive. What is more probable is a gradual reduction, with the Fed Funds rate likely to move 50 to 75 basis points lower towards the end of the year.
A similar scenario is unfolding in Canada after GDP growth picked up at the end of 2023, putting the Bank of Canada on the sidelines.
Inflation remains the key fundamental for the bond market outlook. With the recent economic strength, accompanied by escalating wages, it will likely prove difficult to reach the avowed 2% inflation target. Should that prove to be the case, it stands to reason that longer-term bond yields will rise. This also reflects the massive borrowing requirements as there is no attempt to rein in federal deficits. In addition, the Federal Reserve is still engaged in quantitative tightening.
The net effect will be an eventual return to a positive yield curve with short- and mid-term yields falling below longer-term yields.
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January Outlook
January 22, 2024 | By Hank Cunningham
The bond market rallied further after the recent dovish comments from the U.S. Federal Reserve, pushing yields lower at all maturities. Several Fed officials have been quick to douse the market enthusiasm for near-term reductions in the Federal Funds rate, conditioning investors to be patient. Too early a reduction could be counterproductive to its inflation fight. What is more probable is a gradual move to lower rates with the Fed Funds rate likely to settle in the 3%-4% level.
Importantly, while inflation has steadily improved, it is becoming sticky around 3% and expectations have inched higher. Also, the labour market remains healthy with the unemployment rate low and as wage growth has moved to 4%. Belying recession forecasts, corporate bond spreads remain tight to government bonds.
Besides this, the bond market must deal with not only the tsunami of U.S. Treasury bond issuances to fund the deficit but also ongoing quantitative tightening.
This argues against further declines in bond yields, especially long-term bonds. At 4.1%, the U.S. 10-year offers investors no premium over inflation and may not fall in yield from here. It could possibly move higher.
The net effect will be an eventual return to a positive yield curve with 3% as its base and the two- to six-year maturities falling below the 10-year and longer.
The Bank of Canada faces a weaker economy than the Fed, and it would like to begin to reduce its bank rate but is being restrained by stubborn inflation and strong wage increases. Our mid-term rates should follow those of the U.S., thus permitting some badly needed relief in mortgage costs.
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