Monthly commentary - Mackenzie Fixed Income Team

Written by the Mackenzie Fixed Income Team

Key positioning

• US Treasury yields prolonged its south bound trajectory supported by cooling inflation prints in line with expectations as well as easing labor conditions building a disinflationary soft-landing view.
• Bonds saw a significant bid for duration taking clues from the Dec FOMC meeting which unexpectedly signalled change in forward guidance suggesting a propensity towards rate normalization rather than persisting with a 'higher-for-longer' rate regime.
• Canada’s inflation is proving to be a bit stickier, however the labour market and consumer have deteriorated more rapidly. Nevertheless, we believe Bank of Canada is unlikely to be too far off the Fed’s easing cycle.
• We continue to see value in low to mid duration investment grade corporate bonds, select emerging markets (Brazil, Mexico) while we trimmed our long TIPS positioning in favour of nominals.

Central Bank Watch

The US Fed (Fed)

The turning point this month was the December FOMC where the committee left the policy rate unchanged but unexpectedly signaled a change in the forward guidance suggesting a propensity towards rate normalization rather than persisting with a 'higher-for-longer' rate regime. The change came with Fed’s preferred inflation gage - 6 month annualized core PCE at 1.9% below the 2.0% target Fed is striving to attain. While the US labour market remains strong with a 3.8% unemployment rate, we believe there are cracks showing beneath with respect to private job creation, the quits rate, the hiring rate.

The Bank of Canada (BoC)

Canada has an opposite problem to the US with inflation proving to be a bit stickier, but the labour market and consumer have deteriorated more rapidly. Regardless, going up we thought the Bank would keep policy rates within 50bp of the Fed and at this point in the cycle we do not anticipate that would deviate on the way down. Where we would be surprised is if there was a housing market implosion that become unruly. We believe April’s BoC meeting is live for a potential rate cut, its first of the cycle, while the Fed is toggling between March or May.

The European Central Bank (ECB)

The Eurozone's economic challenges persist, with inflation proving more stubborn, partly driven by wage pressures. The Eurozone headline inflation picked up to 2.9% y/y in December, as expected, from 2.4% in November driven by energy base effects, while core inflation fell to 3.4% y/y from 3.6%. Most importantly, the underlying momentum in inflation continued to ease with 3m/3m seasonally adjusted annualized core inflation significantly lower than 2%. The ECB recognized the significant deceleration in core inflation leading to a less hawkish forward guidance.

The Bank of Japan (BoJ)

The BoJ maintained its distinct stance, continuing with its ultra-accommodative monetary policy and unsurprisingly upheld its negative interest rate policy. An increasing bid for duration globally will make it difficult for JGB yields to make material gains higher in the coming months and with Japan’s “Shunto” wage negotiation round about to occur later in Q1, the BoJ now looks poised to be on hold until at least the new fiscal year, starting April 2024.

Emerging Markets (EM)

EM local rate bonds continued to do well, propelled by a weakening US dollar, lower US rates, and a 'risk-on' sentiment. We continue to favor commodity-exporting nations in Latin America and expect them to continue outperforming, though political instability remains a significant risk factor, with 2024 marking a pivotal political year with elections across the globe. The distinction between commodity importers and exporters has become increasingly pronounced, suggesting a potential divergence in outcomes.

Duration and Curve Positioning

We continue to employ a tactical approach to duration, predominantly favouring the short-end and belly of the curve in North America. We like duration in regions where real yields are higher and/or policy rates have likely peaked, like in Latin America, while underweighting areas requiring further policy interventions. We have modestly increased duration by reducing short positions on the long end of the US curve, reflecting a balanced risk-reward perspective. In regions like Japan, where normalization of monetary policy is necessary but delayed, we maintain a short duration stance.

Investment Grade Corporates

High quality corporates continue to do well as yields softened & duration outperformed on lower inflation and building rate cut expectations. We believe that investment grade bonds continue to demonstrate strong credit fundamentals despite moderately tighter spreads. From a total return basis, short term corporate bonds present a compelling value proposition, particularly in a falling rate environment. 

High yield bonds

HY bond returned +3.63% for the month of December alongside a 4.5% gain for the S&P 500 as markets price in earlier and more aggressive easing in 2024. The HY index provided gains totaling +13.51% in 2023 with CCCs outperforming Single B and BB rated bonds. These were the strongest gains for high-yield bonds since 2019’s 14.1% gain. From a spread perspective, current levels provide a limited but likely adequate buffer over treasury yields in a soft-landing scenario despite the tightening that we saw in 2023. Our preference is in the higher quality spectrum of the high yield market and are positioned accordingly with a growing weighting to the BB-rated category year over year.

Leveraged loans (LL)

US LL closed 2023 on a high note, as views that the Fed was done with rate hikes and that there might indeed be an economic soft landing sparked rallies across risk markets. LL index topped off an exceptionally strong year with gains of 1.65% in December & 13.3% in 2023, its highest annual reading since the Global Financial Crisis and the second-strongest return ever as gains were primarily driven by higher coupons. Only one out of 74 sub-sectors in the benchmark recorded a negative return in Dec while CCC rated loan outperformed higher rated loans.

Bond stories

Investment Grade – Duration Outperformance

IG corporates finished the year on a strong note that resulted in an 8.4% return for the year. After middling through much of the year, IG Corps rallied sharply in November and December with gains of 5.6% and 4.1% respectively, driven largely by the sharp move in treasuries. The expected Fed “pivot” resulted in IG Corp bond appreciation from both the inverse relationship to falling yields, as well as improved risk sentiment that drove tighter spreads and strong performance across the entire ratings spectrum. Looking ahead, we continue to have strong conviction on the investment grade universe due to 1) High convexity providing positive expected value absent a ‘target’ on the direction of interest rates, 2) strong price appreciation potential, 3) lower credit risk in higher quality credit.

High Yield Bond – QBRCN

Quebecor is the 4^th largest telecommunications company in Canada and one of the largest Canadian high yield issuers. While their mobile and wireline businesses have historically been concentrated in Quebec, in 2023 they closed their purchase of Freedom Mobile, giving them a presence in the English-speaking part of Canada. This acquisition came at an attractive price for them and gave them a complementary new growth vector. It also led them to be active in the latest spectrum auction in Canada, which surprised to the upside with much more disciplined spending than markets expected. This offered reassurance that Quebecor’s leverage would remain in check and their path to deleveraging would resume in short order. This confirmed Quebecor’s rising star status and highly anticipated upgrade to investment grade. As a result, their bond spreads reacted positively and outperformed to close off 2023. We continue to see significant spread compression potential versus their investment grade peers and maintain a large position in Quebecor bonds.

ESG – New Zealand Government Green Bond

The team’s holdings in New Zealand outperformed most other fixed income markets over December and were notable contributors to performance across a variety of global and sustainable mandates. As global interest rates fell, New Zealand saw the most significant curve tightening, while also benefitting from the country’s higher initial yields. As economic data shifts looked to create opportunities in New Zealand, the team has tactically increased exposure to the country since Q4 2022. Since participating in the inaugural green bond issuance, spreads have tightened to peer developed market government bonds delivering resilience through the expected conclusion of the tightening cycle from the Reserve Bank of New Zealand.

As the team continues to embrace a global approach to sustainable investing, we continue to believe that unique opportunities to deliver investment returns and environmental impact will be found through taking a global perspective on innovative financing opportunities.

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