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North American central banks are being cautious about rate moves because they don’t want a repeat of 1970s-era reversals that sowed market confusion, says Dustin Reid, vice-president and chief fixed income strategist with Mackenzie Investments.

Reid said interest rates are a difficult weapon to master in the fight against inflation — something central banks were just learning 50 years ago.

In the ’70s, “the Fed eased rates and then, whoops, inflation came back in. We didn’t actually have it beat, and [needed] to hike rates again,” he said. “That back and forth can cause a lot of things, including recession and poor productivity.”

He said markets adapt better to harsh economic circumstances, including high interest rates, than to uncertainty.

“Back and forths can cause firms to back away from investing. And I think that’s what the Fed and other central banks are trying to avoid,” he said.

Reid said most global central banks missed the early read on the stickiness of inflation and had to play catchup when it proved not to be transitory. They are now leery of prematurely saying inflation has been defeated.

Nevertheless, he believes the Fed is on track to start reducing interest rates in May 2024.

“As long as the Fed is relatively sure that inflation isn’t going to spike back higher because of a very strong economy, then I think it’s going to be relatively comfortable easing rates this year and, starting in May, embarking on a rate-easing cycle of as much as 150 basis points.”

In Canada, however, inflation has been more structural and the economy hasn’t rebounded as well.

“That’s definitely causing the Bank [of Canada] and Governor Macklem a little bit more concern about easing rates,” he said. “But I do expect the bank to cut at least 100 basis points this year.”

Despite the delicate economic conditions, Reid said there are opportunities in fixed-income investments.

“Generally speaking — not always but generally speaking — when central banks are about to embark on rate-easing cycles, those are constructive times to buy fixed income, because you’re buying at a price and yields head lower,” he said.

He likes the shorter end of the curve, pronouncing the long end still too unpredictable. He also believes in mixing Canadian exposure with U.S. and emerging-market exposure, currencies and alternatives.

“All of those things are important in terms of putting together a well-balanced portfolio,” he said.

“We generally like North American duration, particularly in the shorter to middle part of the curve,” he said. “Beyond that, some other trades that we like are in the EM space. Since last year, we’ve been buying Mexico and Brazil local currency debt. We’ve added them to our portfolio, unconstrained,” he said.

He also likes investment-grade bonds, particularly in the three- to seven-year space.

“In the investment-grade space, we’re picking up high-quality Canadian or North American firms that are paying a premium over the sovereign curve, and that have very, very little chance of defaulting,” he said.

“It’s probably a good time for duration and a good time for investors to make sure that they’re invested in fixed income after a couple of tough years,” he said. “We’re going to continue to focus on the rate-easing cycle for the balance of 2024 and into 2025, as it relates to fixed income and where to find value for our investors in our funds.”


This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.

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