In its latest Bond Strategy report, BMO Nesbitt Burns recommends a switch to mid-term issues.

The investment dealer observes that Treasury and Government of Canada yields have continued to head higher as inflation concerns resurface, equity markets rally, and central banks appear to be close to the end of their easing cycles.

“As yields increased, the middle of the Canadian curve steepened but the long end flattened. This presents a compelling opportunity for investors, as yields retreat in the middle part of the curve, particularly in the 5- to 10-year area.” For June, BMO Nesbitt Burns recommends a shift from the short- and very long end of the curve, into medium-term bonds.

It says Government of Canada bonds should mildly outperform Treasuries over the next 12 months, especially if the loonie recovers somewhat. “Canadian yields will offer a premium to U.S. yields even though Canada still has lower core inflation.”

The investment dealer suggests a similar move on the corporate side. While high yield bonds may have been the best place to be so far this year, BMO Nesbitt Burns says, “A recent widening of credit spreads and lingering downside risks to the economic environment do not support a shift into those sectors. Instead, higher rated short- and mid-term corporate bonds (AAA/AA) offer a better risk/reward tradeoff.”

BMO Nesbitt Burns suggests that with corporate debt issuance up, spreads are likely to trade in a narrow range. It notes that $4.7 billion in new paper came to market in May. “The increasing number of new issuers have most likely taken encouragement from the favourable reception experienced by new product in the spring.”

It notes that demand for new issues continues has allowed several issuers to come to market, including Investors Group Inc., Canadian Tire Corp., TransAlta Corp., Loblaws Inc., Thomson Corp., and the Greater Toronto Airport Authority. BMO Nesbitt Burns expects the new supply of new corporate issues to continue as demand remains strong.

BMO Nesbitt Burns believes both the Bank of Canada and the Federal Reserve cutting interest rates another 50 basis points this year. “We believe that inflation concerns are overblown, and that the North American economic outlook suggests that inflation is likely to decline over the next year.”