Market review
Investor expectations for interest rate cuts from the Bank of Canada (BoC) faded during the first quarter (Q1) of 2024 even though inflation continued to trend closer to the central bank’s target.
Better-than-expected economic releases in both the U.S. and Canada seemed to suggest there is no urgent need for rate cuts. This created a bearish tone for government yield curves, and seven-year Canada bonds climbed 34 basis points (bps) in Q1.
In Canada, loose fiscal policy in the form of budgetary deficits from provincial and federal governments has counterbalanced the tight monetary policy tone set by the BoC. While Canada’s combined provincial and federal budgets deficits are less than the U.S. government’s deficits as a percentage of GDP, the debt-fueled fiscal policy is expected to keep pressure on governments to issue more bonds. Provinces, for example, will now need to issue almost CA$2.5 billion of bonds per week as part of their 2024/25 financing programs. As a result, long-end provincial credit spreads lagged this quarter and spreads moved 1 bp wider.
Despite a slew of corporate bond issuance in Q1, spreads tightened during the quarter. This was supported by positive investor flows into fixed income and positive rating actions from credit agencies. With over CA$38 billion in corporate issuance in Q1, it was the fourth busiest quarter ever in Canada and was evenly balanced across all three months of the period. The 5–7-year term was the most common issuance term, while the supply of corporate bonds in the 10-year and longer terms continued to decline as a percentage of total corporate issuance. Canadian corporate credit spreads tightened by 13 bps in Q1, led by higher beta debt and subordinated bank debt in the front end. It also outperformed U.S. credit corporate spreads, which tightened by 9 bps.
Market outlook
Economic growth has been strong in both Canada and the U.S. so far. Economists estimate Canada’s GDP will grow by 1% and by 2% in the U.S. in 2024.
While inflation has continued to slow, concerned policymakers are waiting for further evidence that inflation can fall to their targets of 2%.
At the start of the year, the BoC expected core inflation to be above 3% in Q1 but inflation has trended lower and the improvements in the Consumer Price Index (CPI) basket of goods has been more broad-based.
In the U.S., services inflation moderated even as consumer demand has continued to be strong. However the U.S. Federal Reserve (the Fed) has alerted markets about the uneven progress in inflation’s path and that it will continue to look for evidence that the downward trend in inflation is still intact.
The BoC struck a similar tone in that inflation data needs to be closely scrutinized before the central bank can cut rates.
In 2023, Canada created 400,000 jobs and its unemployment rate stood at 5.8%. But in early 2024, the unemployment rate edged up to over 6% suggesting that the labour market is cooling. This should also contain wage increases, which remains high.
In the U.S., job growth has been robust and the labour market remains tight. Yet, wage increases are moderating. While this has been puzzling, the uptick in immigration has been an important driver of improving labour supply.
Both the BoC and the Fed seem to be moving closer to rate cuts. The BoC is likely to cut rates ahead of the Fed as Canada's employment and growth seem weaker than the U.S. But Canada still has a robust housing market that could tighten further if rates are cut quickly. Other major banks such as the Bank of England and European Central Bank also seem ready to cut interest rates this year.
Fund review
Sun Life Core Advantage Credit Private Pool (the “Fund”), Series F, outperformed its benchmark, the FTSE Canada Universe Bond Index, driven primarily by credit positioning. Canadian public corporate bonds were the driver of the Fund’s outperformance. The Fund’s US$ positions also contributed to relative performance. Rates positioning remained relatively neutral to active returns in the quarter. SLC Management Short Term Private Fixed Income Plus Fund’s additional carry over short public corporate bonds also contributed to the Fund’s outperformance.
During the quarter, the portfolio management team reduced the Fund’s underweight in government bonds while trimming its overweight in financials. The Fund participated in new issues of corporates such as TMX Group, John Deere and H&R REIT.
