Week of March 6, 2023

Dec Mullarkey, CFA, Managing Director, Investment Strategy and Asset Allocation

Don’t complain too much about your job. You could be the Fed chief, Jerome Powell, and have to spend two days being grilled by Congress. At times it got testy. Particularly the awkward premise, that rate hikes are meant to stall the economy which causes job losses. Powell’s counter, that high inflation is more pernicious for everyone in the long run, may seem like a devil’s bargain but that nuanced trade-off is what his job entails. 

Powell’s update did change the outlook. Markets now expect the Fed Funds rate to climb to over 5.6% before it pauses. And the prospects of rate cuts later in the year have been dialed back.

The writing had been on the wall. Global activity is picking up with the service economy rebounding. Jobs are plentiful and households are flush with cash. Talk of an economic “hard landing” have shifted to perhaps “no landing.” However, inflation needs to be corralled and central banks are tasked with making that happen with fairly blunt tools. Something needs to give or break. And the longer it takes the more severe the correction. Not an easy job.        

Source: Bloomberg

Randall Malcolm, CFA, Senior Managing Director and Portfolio Manager, Public Fixed Income

As expected, the Bank of Canada left its target for the overnight rate unchanged at 4.5% on Wednesday, a departure from the more hawkish Federal Reserve. Parsing the statement, their expectation seems to be for the economy to slow and labour market tightness to ease, but they did emphasize that they remain poised to raise rates if the data warrants it. The effect on markets was to weaken the Canadian dollar to 1.38 and solidify the bid for Canadian short-term rates. Interestingly, we are seeing short term 5-year inflation expectations rising from 1.80% in mid-January to over 2.20% now, while longer term 30-year inflation expectations have fallen from 2.20% at year end to below 1.90% now. Another divergence that has caught our eye is the MOVE index of US treasury option’s implied volatility has been increasing toward recent highs while the VIX index of SPX option implied volatility has been decreasing toward recent lows.

Andrew Kleeman, Senior Managing Director, Head of Corporate Private Placements

Pricing in the IG Private Credit market appears rational for now. Deals featuring credits that are easy to understand and that have a strong business model are oversubscribed with lower illiquidity premiums compared to public bonds. Deals from niche sectors or that require heavier underwriting are getting higher relative value compared to public bonds to compensate investors for the work, and the ability to negotiate deal terms is much stronger. In addition, subscription levels are lower for these more complex deals. In comparison, at this time last year the IG Private Credit market was very aggressive in bidding for bonds; even tough deals were getting done consistently with insufficient relative value for our standards. On the other hand, during the pandemic excess value was available even on simpler credits due to the market disruption. It isn’t often we see a “Goldilocks” market where the market distinguishes so well between credits.

Source: Private Placement Monitor, 2023.

John Bichajian III, CFA, Senior Director, Derivatives & Quantitative Strategy

Interest rate differentials and foreign exchange are inextricably linked. As a result, understanding the interest rate environment in both countries is important in understanding USD/CAD performance. The Canadian economy is more sensitive to interest rates than the U.S. economy, which is the main driver behind the recent sharp divergence between expectations for further rate hikes in the two countries. 

In his testimony to the U.S. Congress, Chair Powell suggested the Fed would be prepared to increase the pace of rate hikes should the data warrant and the market began to price in over 75bps of hikes by May, as opposed to the 50bps priced in at the start of the week.

On the same day that Powell completed his testimony, the Bank of Canada kept rates unchanged for the first time in nine meetings, which lead the market implied terminal rate difference to approach 90bps and pushing USD/CAD higher.

Front end interest rate spreads will be a key determinant for USD/CAD performance in the coming months, as both the BoC and Fed strive to suppress inflation while inflicting as little pain on the economy as possible. 

Market insights are based on individual portfolio manager opinions and market observations. These are observations only and are not intended to provide specific financial, tax, investment, insurance, legal or accounting advice and should not be relied upon and does not constitute a specific offer to buy and/or sell securities, insurance or investment services. Investors should consult with their professional advisors before acting upon any information posted here.

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