Quarterly Canadian fixed income outlook

Attitudes in the Canadian fixed income markets differ markedly from those among equity investors. Whereas equities have been upbeat and enjoying low volatility in the first half of this year, bond markets have recently become more volatile as they acknowledge uncertainty in the global economy. We project a period of global recession in our baseline scenario, along with a more stable period for bonds over the next year, as outlined in our Perspectives report.

While the global bond market proved relatively stable overall in the second quarter, we have seen more volatility lately. The WGBI index, Canadian dollar hedged, remained flat during Q2 and up 3.00% during the year to date, but bond markets are now acknowledging uncertainty about inflation and monetary policy. For details, read FTSE World Government Bond Index (WGBI) Series Opens in a new window. 

Our quarterly fixed income outlook anticipates that bond markets will soon begin to feel the full impact of central banks’ quantitative tightening. This could be compounded as governments begin issuing more T-bills to replenish their near-empty cash balances at central banks. We also believe yield curve inversions show sovereign bond markets are pricing in the recession.

Although we expect the US Federal Reserve to maintain a restrictive policy rate as it pursues its goal of controlling inflation, we anticipate that it will reach its terminal funds rate in the next quarter or so. This aligns with market expectations and suggests bond market volatility will decrease compared to the previous 12 months. For details, read Inflation: Progress and the Path Ahead Opens in a new window..

Decomposing the nominal bond yield into its real and breakeven inflation components creates a base case for stable bond yields over the forecast horizon. During Q2, 10-year real bond yields increased above 1.6%, which is sufficiently restrictive to achieve the Federal Reserve’s inflation objectives.

Structural factors will keep breakeven yields higher than in the past, providing added yield rate compensation for taking interest rate risk with bond ownership. Breakeven rates could even increase if the economy proves to be more resilient than expected.

These factors lead us to anticipate positive returns from global bonds over the next year, with 10-year treasury yields trading between 3.00% and 4.25% on a pivot point of 3.50%.