Week of October 28, 2024

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

As we enter the final sprint in the election, in what is shaping up to be a coin-toss for President, markets have already been shifting.

First up, fiscal policy is a top concern. Over the last month the spike in Treasury market volatility, and the companion rise in the 10-year yield, reflect concerns that neither candidate is much better than the other for fiscal discipline. But the specific makeup of the government – between the Oval Office and both chambers of Congress – is critical to how harsh the deficit impact could be.????

Another asset that is reacting to heightened risk is gold. U.S. campaign rhetoric around tariffs and penalizing countries that abandon the dollar is forcing countries to engage in more risk management of its reserves. Central banks continue to beef up on gold and tilt away from the dollar. If the election outcome results in more disruption to trade, that trend could accelerate.

Meanwhile equity investors continue to focus on growth. This has been supported by solid GDP numbers and an earnings season that is beating expectations. However, there have been some shifts. While momentum stocks dominated in the first half of the year, the best performing group in the second half has been high dividend stocks. High dividend payers are predominately in sectors like real estate, utilities, financials and consumer staples. These are domestically focused, in both their inputs and sales, and therefore better insulated from the risk of tariffs.

Sources: Bloomberg, Financial Times, 2024.

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Daniel Lucey, CFA , Senior Managing Director, Senior Portfolio Manager

The overall rate environment has seen a backup in longer-duration fixed income yields. This is in part a result of the bond market continuing to respond to more favorable U.S. economic conditions, with data signaling a higher growth environment than was previously anticipated only a few months earlier. The move higher in 10- and 30-year Treasury yields is likely due to a combination of factors, from the proverbial pendulum swinging back after the markets “over-anticipating” a more rapid rate cut environment earlier in the year, to more scrutiny of both presidential candidates’ outlook for spending, the inflationary effects of potential tariffs and the ballooning debt/GDP ratio of the U.S. economy.

As current coupon and higher coupon (or “up-in-coupon”) 30-year fixed rate mortgages have underperformed the Bloomberg US MBS Index overall, we have seen investment opportunities emerge. Further fueling the opportunity set are agency mortgage-backed securities (MBS) underperforming other spread duration asset classes such as investment grade corporates. With rate volatility spiking coming out of the Federal Open Market Committee and the subsequent selloff across the yield curve, the market is pricing the increased uncertainty of near-the-money or in-the money mortgage cashflows, which is typical with a spike in interest rate volatility.

This uncertainty is driving spreads up the coupon stack significantly wider. For an easy read on interest rate volatility, we can look to the Merrill Lynch Option Volatility Estimate (MOVE) Index. The year-to-date low in the MOVE Index was 82 in mid-May, and has since spiked all the way to almost 132 at the time of writing, a level which is the high mark of the year. Unless interest rate volatility settles down, we believe agency MBS spreads will likely stay elevated in these negatively convex coupons.

The good news is that the forward-looking bond market is already pricing in much of this volatility. This could make agency MBS and agency commercial MBS an interesting segment of the market in which to put money to work, especially as corporate credit remains near multi-year tights in spread.

Source: Bloomberg, 2024.

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

Canadian GDP released for August showed a slowing economy with no month-over-month growth from July and lackluster 1.3% growth year over year. Combined with falling core and headline Canadian inflation, this easily puts another 50 basis-point (bp) rate cut in play for the Bank of Canada’s last 2024 meeting on December 11. While the bond market still looks split on a 25- versus 50-bp cut at the December meeting, the Canadian dollar’s weakness implies the Bank of Canada is likely move rates lower faster than the U.S. Federal Reserve.

Source: Statistics Canada, 2024.

The information may include statements which reflect expectations or forecasts of future events. Such forward-looking statements are speculative in nature and may be subject to risks, uncertainties and assumptions and actual results which could differ significantly from the statements. All opinions and commentary are subject to change without notice. SLC Management is not affiliated with, nor endorsing, any third parties mentioned within this article.

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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