Canada's stealth recession and the global fixed income pivot

This article was produced in partnership with Franklin Templeton

Canada is experiencing a stealth recession masked by government spending and immigration. According to Darcy Briggs, senior vice president and portfolio manager with the Franklin Templeton Fixed Income Group. While Canadian growth remains sluggish, the U.S. is chugging along with robust consumption and investment. Yet, both countries find themselves part of a broader, synchronized easing cycle as central banks around the world pivot to support their economies.

“Productivity in Canada has been declining for three years, dragging down real GDP per capita and limiting economic potential. Unemployment rates are rising on both sides of the border, adding pressure to households. And perhaps most critically, we’re bracing for a potential ‘mortgage wall’ that could hit full force by mid-2025,” Briggs explained.

Franklin Templeton’s fixed income approach addresses these challenges by combining Canadian bonds with global diversification to optimize both risk management and return potential.

The Franklin Canadian Core Plus Bond Fund integrates a mix of government and corporate bonds within Canada while also leveraging global markets to access asset classes unavailable domestically, such as high-yield bonds and syndicated loans. The fund also employs yield curve positioning, for example, based on evolving economic data, such as rising unemployment rates or the impending “mortgage wall.”

Inflation and policy shifts: The big picture

Central banks worldwide are now firmly in an easing cycle, a stark reversal from the aggressive tightening of recent years. “The Bank of Canada and the Fed have both started cutting rates, and we expect this trend to continue, with more aggressive easing from the Bank of Canada and that from the FED” Briggs says. “Real interest rates are still highly restrictive, especially in Canada, where households are struggling under the weight of debt servicing costs.”

He highlights the importance of this shift for fixed income investors. “This global easing cycle is creating opportunities, but it’s critical to understand where and how to position portfolios in this environment.”

Inflation has softened significantly from its 2022 peaks. In Canada, headline and core inflation have fallen back within the Bank of Canada’s target range, though housing costs remain a major factor. “If you strip out mortgage interest cost, CPI in Canada is actually running at about 1.4%^[1],” Briggs observes. “This tells us that inflationary pressures are being distorted by housing rather than broader economic overheating.”

In the U.S., inflation is trending downward as well, although core inflation remains stickier. That said, the Federal Reserve has already started cutting rates, with an aggressive 50-basis-point move surprising many observers. “A cut of that size is typically reserved for crises,” Briggs notes, “but it seems the Fed is trying to front-load easing to get ahead of potential economic risks.”

The fixed income response

Briggs highlights the importance of being proactive and strategic in fixed income investments. “Duration is back in play,” he emphasizes. “We believe rates still have room to move lower, particularly in Canada, where economic conditions justify further cuts.”

Briggs points out, “Canada’s bond market is relatively small, and diversification is critical. Our fund leverages global markets and asset classes like high-yield bonds and syndicated loans to enhance risk-adjusted returns.”

The fund’s active management has also enabled it to respond effectively to market changes. “During periods of uncertainty, such as the Ukraine crisis, we’ve adjusted our exposures dynamically,” Briggs says. “Now, we’re finding attractive opportunities in the front end of the corporate yield curve, which offers high carry with limited sensitivity to interest rate and credit spread changes.”

Briggs also emphasizes the importance of aligning strategies with the evolving yield curve. “The Canadian yield curve remains inverted but is beginning to steepen. As central banks continue cutting rates, we expect the front end to shift lower, creating opportunities in duration.”

Franklin Templeton’s active management approach is designed to adapt to these shifts. By dynamically adjusting credit exposures, duration, and yield curve positioning, the firm aims to capitalize on changing economic data while maintaining a balanced risk profile.

For those hesitant to extend duration, Briggs suggests short-term fixed income solutions as a middle ground. “Short-duration strategies can provide a stepping stone for investors who want to stay conservative while benefiting from higher yields in the current environment.”

As bond markets grow more complex in the short term, the strategies that have served investors well in the past may no longer be sufficient. The Franklin Canadian Core Plus Bond Fund allows for up to 30% of the portfolio to explore the “plus” components. This flexibility enables the fund to capitalize on opportunities in high-yield bonds, emerging markets, and other areas outside of Canada’s relatively small bond market.

Moreover, the strategy is built on a proven track record of consistent performance. The fund delivers yields that are 1.6 times higher than its peer group. Over its 37-year history, the fund has delivered net positive returns in 31 years, with 19 of those years generating an annual return of 7% or higher.^[2]

What also sets Franklin Templeton apart is its global fixed income platform, which provides real-time insights from teams across the world. For example, lessons learned from Australia’s three-year mortgage reset cycle, which bears similarities to Canada’s looming five-year reset, have informed strategies to anticipate potential consumption slowdowns. Similarly, insights from Franklin Templeton’s team in Mexico have guided dynamic adjustments to portfolios in response to changing political and economic conditions. This global perspective, paired with local expertise, equips the fund to respond to emerging trends and market shifts with agility.

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