Monthly commentary - Mackenzie Fixed Income Team

Written by the Mackenzie Fixed Income Team

Key Highlights

• We favor longer-duration U.S. Treasuries due to their attractive inflation-adjusted returns, while reducing exposure to Canadian government bonds.
• Rising long-term yields due to inflation concerns is a chance to secure higher returns on risk-free assets, especially beneficial for long-term investors. inflation-protected securities like long-term TIPS.
• New Zealand government bonds are overweighted, supported by ongoing rate cuts and strong fiscal health, offering a compelling alternative to U.S. debt.
• Inflation data varies across emerging economies—Brazil shows easing inflation, Mexico sees a slight uptick, and Indonesia cuts rates amid stable prices—highlighting the need for selective positioning.
• High yield bonds and leveraged loans delivered strong returns in May, driven by easing trade tensions, resilient Q1 earnings, and improved economic outlook. High yield spreads tightened, with CCC-rated bonds and loans leading performance. There is a deliberate move away from riskier cyclical sectors and overvalued areas, with a shift toward higher-rated credit.

Fixed Income Market Update

U.S. government debt is under pressure from both ends of the yield curve, driven by the Fed’s commitment to restrictive policy and growing fiscal concerns. These dynamics are pushing yields higher, particularly on the long end, as investors demand greater compensation for long-term risk. Despite the current pessimism, this bearish outlook widely accepted and priced into the market. There is growing pressure to roll out fiscal spending to reassure businesses and investors, helping them shrug off short-term economic hiccups or self-inflicted wounds from trade policies. The U.S.-led trade war is not over, but investors are increasingly hopeful that tensions will cool off for good. As a result, the bond market’s focus is shifting from fears of a U.S. or global economic downturn and potential central bank rate cuts to concerns about stubborn inflation and bigger government deficits.

There is a growing market camp that the U.S. might be headed for a touch of stagflation—slow growth paired with persistent inflation. The Fed is less likely to rush into easing monetary policy, while the euro area could see stronger growth and less deflation, which also weighs on government bonds. Expect fiscal stimulus and more debt issuance to put upward pressure on U.S. Treasuries and, to a lesser extent, German Bunds.

The proposed Section 899 of the U.S. tax code, introduced under the House Bill, marks a significant shift in how the U.S. plans to tax foreign investors. This legislation targets countries deemed to impose "unfair foreign taxes"—such as digital services taxes or measures under the OECD’s Pillar Two framework—by classifying them as “discriminatory foreign countries.” If enacted, it would override existing tax treaties and impose higher U.S. tax rates on investors from these jurisdictions, including Canada.

This development is prompting a reassessment among global investors. The cost of holding U.S. dollar-denominated assets is rising, not just due to market dynamics but also because of these looming tax penalties. As a result, investors are increasingly looking to hedge their U.S. exposure and may begin to reduce their holdings. This shift in sentiment could contribute to a structurally weaker U.S. dollar in the quarters ahead, as capital flows adjust to the new tax landscape.

Fund Positioning

In the current fixed income landscape, our strategy is expressed by being overweight portfolio duration in US treasuries and underweight in Canadian government bonds reflecting a nuanced regional allocation. Simultaneously, we continue to reduce sector specific risk in cyclicals and at expensive valuations with greater focus toward increasing exposure to higher-rated credits.

While inflationary concerns have led to a steepening yield curve, it also presents an opportunity to earn higher risk-free yields. That opens the door for a potential shift, especially since long-term U.S. Treasuries now offer real yields of about 2.80% after accounting for inflation—an attractive proposition for long-term investors. For long-term investors, this may be a strategic moment to consider increasing exposure to long-dated TIPS. 30 year real yields at 2.8% offer a solid opportunity to preserve and grow purchasing power over time. While short-term momentum is negative, the widespread bearish sentiment suggests a potential turning point, making TIPS a strategic bet as a potential hedge against inflation and a way to reduce portfolio volatility amid ongoing equity market uncertainty.

We remain overweight duration in New Zealand where the curve flattened as the central bank delivered sixth straight cut to 3.25%. Due to its fiscal sustainability NZ bonds are much better place for investors looking to diversify out of US treasuries, relative to other developed markets. In terms of our emerging market exposures, Brazil's CPI came in lower than expected, which is significant as it is one of the first instances of lower-than-expected CPI since January. This data may not change the overall picture for Brazil's central bank, which has already hiked rates significantly. Mexico's CPI came in slightly higher than expected, both on the core and headline sides. This data may not change the case for continued rate cuts in Mexico but is something to monitor. Bank of Indonesia reduced rates amid cooling domestic economic growth, benign inflation, and a stronger rupiah. As headline CPI inflation eased to a lower-than-expected 1.6% y/y in May from 1.9% in April contributed from a deeper decline in food prices. Bonds have also rallied on sustained demand from foreign investors buoyed by an extended decline in dollar. 

Central Bank Watch

Credit Market Performance

High yield bonds and leverage loans posted strong gains as a de-escalation of the trade war helped reduce recession risks and boost sentiment across risk assets further held by better-than-feared 1Q earnings. High-yield bond yields and spreads declined 38bp and 61bp in May to 7.61% and 363bp. The HY index provided a +1.75% gain in May with CCCs (+2.9%) outperforming Bs (+1.7%) and BBs (+1.5%). Leveraged loans benefitted from an improvement in growth sentiment, reset of Fed expectations, robust CLO origination, and steady loan inflows. The loan index provided a +1.6% gain in May with CCC loans outperforming with a 3% return. We continue maintain a neutral position in leveraged loans, reflecting a cautious yet balanced approach to this segment of the market.

Commissions, trailing commissions, management fees, and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. The indicated rates of return are the historical annual compounded total returns as of May 31, 2025, including changes in share value and reinvestment of all distributions and does not take into account sales, redemption, distribution, or optional charges or income taxes payable by any security holder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated. Index performance does not include the impact of fees, commissions, and expenses that would be payable by investors in the investment products that seek to track an index.

Index performance does not include the impact of fees, commissions, and expenses that would be payable by investors in investment products that seek to track an index.

This document may contain forward-looking information which reflect our or third party current expectations or forecasts of future events. Forward-looking information is inherently subject to, among other things, risks, uncertainties and assumptions that could cause actual results to differ materially from those expressed herein. These risks, uncertainties and assumptions include, without limitation, general economic, political and market factors, interest and foreign exchange rates, the volatility of equity and capital markets, business competition, technological change, changes in government regulations, changes in tax laws, unexpected judicial or regulatory proceedings and catastrophic events. Please consider these and other factors carefully and not place undue reliance on forward-looking information. The forward-looking information contained herein is current only as of May 31, 2025. There should be no expectation that such information will in all circumstances be updated, supplemented or revised whether as a result of new information, changing circumstances, future events or otherwise.

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