Buckle up for rising rates
Mortgages, bond market don’t bode well
It has not been a good year for fixed-income markets, as central banks begin to tighten on higher oil prices and concerns over inflation. In particular, all eyes are on the U.S. Federal Reserve, which is leading the charge globally with its recent hike at the end of September, another planned prior to the end of the year and three more expected in 2019.
Consequently, the U.S. 10-Year Treasury yield has reached its highest level in more than seven years at 3.25 per cent, while the 30-year yield reached a fouryear high at 3.44 per cent. Not surprisingly, more than 60 per cent of bond ETFs in the U.S. have posted negative returns this year, according to Bloomberg data.
Here in Canada, the FTSE Canada All Government Bond Index is down nearly two per cent so far this year while corporates haven’t fared much better, with the FTSE TMX Universe Bond Index losing nearly 1.5 per cent.
More specifically, the fiveyear Government of Canada yield has now exploded higher from 0.5 per cent to 2.45 per cent in the past two years. This is rather important at it’s the benchmark for Canadian banks when it comes to setting mortgage rates.
Interestingly, the Canadian dollar has outperformed the two-year yield spread differential implying that currency speculators believe the pace of rate hikes by the Bank of Canada will not only match but potentially surpass that of the Federal Reserve.
We can’t blame them as this is in line with the Bank of Canada’s persistently hawkish stance on further monetary tightening. Unfortunately, while this is helping address an excess amount of leverage among Canadian households this is terrible news not only for bond investors but also for regular citizens as it is already starting to work its way through our economy.
For example, our real mortgage growth rate recently collapsed to levels not seen since the 1980s. This is showing up in our housing market with new starts in September coming in at its slowest reading since 2016 and down nearly 25 per cent since the start of summer.
Besides curtailing home purchases, consumers have also cut back in other areas as well. For example, new vehicle sales were crushed in September falling 7.4 per cent over last year posting the steepest drop since the 2009 recession.
Adding it all up, consumer spending accounts for nearly 60 per cent of Canada’s GDP while real estate, construction and related financial industries account for 20 per cent. Think about that.
For those looking to the rallying oil market to bail us out, don’t look to Calgary for nice weather.
The Western Canada Select discount to U.S. crude oil has blown out to its widest level according to Bloomberg data going back to 2008. While this differential could recover a bit going forward, the ongoing lack of pipeline infrastructure will continue to be a major overhang on the Canadian energy sector and the pricing we receive for our oil.
Finally, poor fiscal decisions by our Federal government are compounding the problem, putting us at a distinct disadvantage to our neighbours to the south when it comes to corporate and personal income taxes.
Therefore, it isn’t surprising that the Ivey PMI Index, a measure of purchasing growth in the Canadian economy, fell to a two-year low of 50.4 in September from 61.9 in August. This is shockingly close to 50, the level at which the economy begins to contract.
When push comes to shove, central banks do keep a very close eye on the bond market and will eventually step in to defend it as the 35-year bull run in fixed income has shown. The problem though, is that most central bank leaders, including our own, tend to respond only after there has already been a material impact on the economy.
Therefore, the question is: has there been enough carnage yet for Bank of Canada governor Stephen Poloz to shift his hawkish outlook to at least a neutral one? For a central bank that has a history of simply following the Fed, we’re not holding our breath on this, so those Canadians either with mortgages or investing in the bond market better buckle up, it’s going to be a bumpy ride. Martin Pelletier, CFA is a Portfolio Manager and OCIO at TriVest Wealth Counsel Ltd, a Calgary-based private client and institutional investment firm specializing in discretionary risk-managed portfolios as well as investment audit and oversight services.