Monthly commentary - Mackenzie Fixed Income Team

Written by the Mackenzie Fixed Income Team

Fixed Income Market Update

Fed Chair Jerome Powell used his final speech at Jackson Hole to signal that the balance of risks has shifted away from inflation and toward the labour market, effectively teeing up a September rate cut. He reiterated the 2% inflation target but stressed that employment risks can emerge suddenly, warning that “if those risks materialize, they can do so quickly in the form of sharply higher layoffs and rising unemployment.” Markets immediately translated this framing into higher odds of a 25 bp move, lower front-end yields, a softer USD, and higher equity prices. While Powell stopped short of a pre-commitment, the shift was clear: the Fed is now inclined to prioritize protecting the labour market over pressing harder on inflation. This marks a sharp contrast with the tone of the July FOMC Minutes, which suggested policymakers still viewed inflation as the greater threat. The result was a swift repricing: rate cut odds for September jumped to nearly 90% and reversing the more hawkish interpretation investors had taken from July’s inflation data.

The immediate debate is no longer about whether the Fed will cut in September, but rather whether it can continue cutting thereafter. Markets currently expect four cuts by June 2026, but the trajectory hinges on tariff pass-through. So far, companies have absorbed the bulk of the costs. While broad consumer pass-through related to tariffs has been largely avoided so far, eventual price pass through may be inevitable if tariffs remain elevated. Powell’s framing fits neatly into this backdrop. He acknowledged tariff pressures but framed them as one-off price adjustments rather than a sustained inflation cycle. The policy hinge is simple: if companies shift more decisively from absorption to pass-through while non-housing services remain sticky, the glidepath back to 2% inflation will slow and the easing cycle could be shallower than markets currently expect. If pass-through remains limited and services cool, the Fed has room to cut in September and proceed cautiously thereafter.

The key takeaway from Jackson Hole is that a key risk that the Fed falling behind the curve has been sidelined for now. Policymakers have made it clear that they are prepared to run the economy hot if that is the cost of protecting the labour market. September looks locked in for the first cut, but what comes after will depend on how tariffs filter through prices and how the labour market evolves in the months ahead. 

Fund Positioning

Our broad duration stance remains overweight, but we have made meaningful adjustments at the regional level. We hold underweight positions in Canadian and European duration, while maintaining a significant overweight in U.S. duration.

One of our core fixed income positioning themes this year has been the anticipated narrowing of the yield spread between U.S. and Canadian 10-year government bonds. Earlier in the year, the differential had widened to ~140bps, a level that stood out as historically extreme, reaching 2.5 to 3 standard deviations depending on the timeframe. We viewed this as unsustainable and positioned for convergence. Our thesis was that the spread would compress primarily via lower U.S. yields, driven by a shift in Fed policy focus toward labour market softness rather than inflation persistence. At the same time, Canadian yields were expected to remain stable or drift higher, given the Bank of Canada’s earlier and more aggressive rate cuts from a higher peak. This view has largely played out, with the spread narrowing to ~80bps, in line with our initial target range. The recent pivot in U.S. rate expectations, particularly over the past 4–6 weeks, has accelerated this move. Markets are now pricing in a more responsive Fed, potentially cutting rates sooner than previously anticipated.

While the U.S. and Canadian economies have not moved in lockstep, they are showing signs of convergence. That said, we remain cautious on the macro outlook for both regions over the next few quarters. U.S. fundamentals, especially household balance sheets, remain stronger, supported by long-term mortgage structures and post-GFC deleveraging. In contrast, Canadian households are more exposed to rate resets and carry higher leverage, making the consumer more vulnerable to volatility. We continue to monitor this cross-market dynamic closely, but with much of the spread compression already realized, we are tactically reassessing the next leg of opportunity.

We made several tactical adjustments across our global fixed income and FX exposures in August, driven by evolving macro conditions, valuation signals, and geopolitical developments. We exited our long TIPS exposure, primarily due to a lack of near-term inflation pressure and muted market reaction to CPI prints. However, with real yields remaining elevated, we remain open to re-entering the position tactically should inflation dynamics or valuation warrant it. We closed our long New Zealand duration exposure, as we believe the trade has largely played out. The convergence of global policy rate paths has reduced the relative value opportunity. One of our more successful trades this month was selling French OATs versus German Bunds in the 10-year segment. This was based on rising political and fiscal uncertainty in France, including risks of government instability, budget rejection cycles, and potential early elections. The trade performed ahead of expectations, validating our thesis that French assets were mispricing these risks.

On the EM front, we selectively added to carry positions focusing on countries viz. South Africa and Peru with high real yields and improving fundamentals. In Indonesia we exited our position in Indonesia ahead of recent currency volatility and political unrest which proved to be well timed.

Central Bank Watch

Credit market performance

The high yield bond index posted +1.3% gain in August with CCCs (+1.6%) outperforming BBs (+1.3%) and Bs (+1.1%). This strength came alongside a notable rally in treasuries and rise in equities, as markets responded to a more dovish outlook for Fed policy amid signs of a cooling labour market. HY yields remain near multi-year lows, with spreads holding steady through the month. Investors absorbed a solid earnings season, consistent primary issuance, and modest inflows with confidence. Notably, this has been one of the strongest reporting seasons in recent years for high-yield issuers, with forward guidance also coming in robust across sectors.

The U.S. leveraged loan market paused in August, with the Morningstar LSTA Index returning 0.45% as secondary prices softened and investor sentiment turned more cautious. Lower rated loans underperformed as CCC loans fell 0.76% while BB rate gained 0.50%. Heavy issuance in July, softer macro data, and subdued BSL CLO formation weighed on returns. However, strong repayment activity reaching a record $54 billion, helped maintain borrower-friendly technicals and underscored investors’ continued need to deploy capital.