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Welcome to Soundbites, weekly insights on market trends and investment strategies, brought to you by Investment Executive and sponsored by Canada Life. For today’s Soundbites, we’re talking with Dustin Reid, vice-president and chief strategist, fixed income with Mackenzie Investments, about the imminent rate decisions expected from both the Bank of Canada and the U.S. Federal Reserve. We talked about policy divergence and how markets are positioned. And we started by asking what he’s expecting from the upcoming central bank meetings.

Dustin Reid (DR): Most people believe that the Bank of Canada is not going to cut rates or hike rates at the meeting. Obviously, the situation in the Middle East continues to be very fluid, and oil prices are up significantly. But I think the Bank is still very concerned about the upcoming USMCA renegotiations. It’s a little more comfortable with domestic inflation — although that’s before the big rise in oil prices. And the Bank of Canada is somewhat concerned about the labour market. We still think that if inflation remains relatively well behaved, that the Bank would want to take the advantage of cutting rates if it can later this year. But the March meeting is probably a pass. On the Fed meeting — the FOMC meeting in March — we also continue to expect no move by the Fed. The Fed believes that the labour market is a little bit more stable and the inflation story is still relatively hot. That probably will not allow the Fed to cut rates, in our opinion.

How markets are positioned

DR: On the Bank of Canada side, the market’s actually pricing about 25 basis points worth of hikes through the end of the year, which is not nothing, but I think that the risk around hikes by the Bank of Canada — particularly in the next six months — are quite low, until we get some sort of final or pseudo-final agreement around USMCA. On the Fed side, we’ve gone from roughly 60 basis points worth of cuts through the end of the year, down to around 25 or 30 basis points worth of cuts. And I think that’s probably about right. But I can see later this year where the Fed may want to get rates a little bit lower. A lot of it, I think, depends on where the Fed believes the neutral rate is.

On policy divergence

DR: We have seen a lot of policy divergence over the last number of years. The Bank of Canada started at around 5% and now is around 2.25%. And the Fed started around 5.5% and is now sitting at around 3.5%. So, I think that the Bank can cut probably twice this year. So, call it 50 basis points. And maybe the Fed cuts by 25. But that’s later this year. So, the policy divergence is relatively in line. Where we might get some spread widening or narrowing, depending on how you look at it, is clearly on the energy side, if this is lasting for a long time. Canada is an energy exporter. The U.S. is not particularly an energy exporter, but it is relatively energy independent. So that could be a source of some differentiation later this year. And then the other risk would be USMCA. And if that fell apart or looked materially different, then I think the premium for Canadian sovereign paper would go up pretty significantly, i.e., yields would probably be quite a bit higher and probably narrow, versus where the U.S. are.

Where he sees opportunities

DR: There’s a lot going on globally. For most of this year, one of our main views has been to be short U.S. duration in the 10s and 30s space. So, prices lower, yields higher. But with the recent move in oil prices and strife in the Middle East, and this initial view by the market that the risk to the global economy is an inflationary shock as opposed to a growth shock, we’ve actually covered our short U.S. duration position and are now slightly long duration. So, prices higher, yields lower. And the idea behind that is that at some point here, if oil prices are “higher for longer,” the market is going to stop trading the thematic of higher inflation, and it’s actually going to start trading lower global growth. And I think that we are close to — although maybe a bit early — into flipping into that thematic. So in the last few days, we’ve flipped from being short U.S. duration, yields higher, to long U.S. duration, yields lower, on the anticipation that that thematic change will happen here and we will have higher-for-longer energy prices. If we get further confirmation of the narrative then we would add additional long duration positions, particularly in the U.S.

Corporate credit and sovereign bonds

DR: So, in the last little bit, the last few weeks, with the volatility in the Middle East and move higher in energy prices, we’ve seen a pretty significant widening in corporate spreads, whether it’s investment grade or high yield. And to be fair, even before that started happening, we did see credit widening happening. Part of that is, I think, also on the private credit story, where people have become a little bit more concerned around private credit and gating and those types of issues. So, people have been moving back towards investment grade over high yield. Clearly the risks around a global recession are higher, so consumer-type names are looking a little bit more vulnerable here.

And finally, what’s the bottom line for investors?

DR: We’ve had a pretty significant move higher in global yields across the board. When you look at U.K. or Europe or some of the emerging market economies, yields have moved pretty significantly higher. So, always keep an eye on long-term goals and long-term investing. If you have an opportunity to get into riskier assets here, and you’re comfortable with that from a very long-term perspective, the market looks like it’s moved quite significantly. And if you think that geopolitics will settle down over the next few months, and oil prices and energy prices broadly will settle down, then these global yields will probably come in. Prices higher, yields lower. So, it’s a good time to be getting into fixed income. But if you have a view that we’re not done yet, and we’re going to see a little bit more strife, and oil is going to be higher for longer, then it’s not quite the time to get in. But at some point, this will also pass, and it will be a very good opportunity to pick up some very good, higher-yielding assets, investment grade or just below investment grade assets in the emerging markets.

Well, those are today’s Soundbites, brought to you by Investment Executive and sponsored by Canada Life. Our thanks again to Dustin Reid of Mackenzie Investments. Visit us at investmentexecutive.com, where you can sign up for our a.m. newsletter and never miss another Soundbite. Thanks for listening.

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