Active investor:
Low interest rates, sluggish economies take the shine off fixed-income investments
The Bank of Canada’s decision to cut the overnight interest rate by 25 basis points to 0.75% took the investment community and consumers by surprise. The question remains, however: Will this provide enough impetus to sustain economic growth in Canada?
The rationale cited by the bank is that its rate cut will act as an insurance against a drag to economic growth that has been induced by plunging oil prices.
“Understandably, markets were shocked since there had been no indication from the bank that this was in the cards,” says Aubrey Basdeo, managing director and head of fixed income for BlackRock Canada. “In fact, the deputy governor indicated only a week prior to the announcement that the market should not expect any drastic changes to the policy outlook.”
The interest rate cut was coupled with the acknowledgement that growth will slow to 1.5% in the first half of 2015. “Expectations are that second-half growth will begin to accelerate based on a pickup in exports and weaker Canadian dollar,” Basdeo says. “But we’re not convinced that will happen.”
Looking to the past decade, Canadian-dollar-sensitive industry capacity declined significantly at a time when the Canadian dollar was on the rise, he explains. “Those that have survived are currently running at elevated capacity. Given those conditions, we don’t anticipate a significant increase in manufacturing sales over the short term.”
Basdeo says with the now lower interest rate, “We’re in a growth-starved market, and we can only expect to see the bank announcing more eases as we face weaker than anticipated growth.”
This also means that fixedincome investors are facing even more challenging and divergent markets ahead. “Central bankers in developing countries are charting their own paths as they face diverging economic realities,” Bas- deo says. “That will be a key driver of both opportunity and volatility in global fixedincome markets.”
However, things continue to be in a state of flux for major global economies, he adds. “Europe and Japan are both showing sluggish economic growth, as monetary policy easing drives yields down. On the other hand, the U.S. is reinforcing its expectations of higher interest rates by exiting quantitative easing in 2014.”
While the paths may differ, Basdeo expects fixed-income yields across developed markets will remain low, despite the fact that the Federal Reserve will likely raise interest rates and the U.S. looks relatively strong for 2015. “At this point in time, we need to wait and see how the economic picture in Europe and Japan turns out.”
Not surprisingly, Canadian fixed income is subject to the same downward pressure from overseas, Basdeo notes. “Given what has happened in recent weeks, domestic interest rates will remain lower for longer than anticipated.”
If and when interest rates do eventually rise, increases will not be evenly distributed across global markets, Basdeo says. “In this current lowyield environment, Canadian investors should consider investing in the short end of the yield curve and keeping the duration of their holdings short. They should also be looking for yield beyond domestic fixed income until the economic weakness in Japan and Europe plays itself out.”
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