Long duration bonds rebounded for fixed income investors in 2023

The final three months of 2023 proved successful for investors in Canadian long government bonds, municipal and provincial bonds according to a new report.

FTSE Russell’s latest Fixed Income Insights report found that, with inflation easing and signs that the Fed is ready to pivot on rates, G7 yields reversed and ended December back at levels seen at the start of 2023, erasing 12 months of yield rises, as median Fed dot plots show 75bp in cuts for 2024.

Investors in long Canadian sovereigns, provis, and munis saw returns of up to 16% in the fourth quarter as the Canadian curve continued to disinvert in December with 20-year bond yields down sharply on expectations of aggressive rate cuts, despite the Bank of Canada caution on its rate policy.

Expectation that the Fed’s rates policy could be followed, or even preceded, by the Bank of Canada is contrary to the Canadian central banks ‘higher for longer’ narrative but with the economy slowing in the third quarter – real GDP contracted 1.1%, defying growth expectation – rate cuts are expected in 2024.

Back into bonds

Investors who have been avoiding bonds during some challenging conditions in 2023 may now decide to swing back to the assets thanks to the low yields environment.

Among recent outlooks on the bonds market:

• Ninepoint Partners’ outlook predicts we could see the best investing environment for bonds in 15 years: “Although transitioning to higher rates has not been good for bonds, the new era we are entering can bring returns for investors with the ability, for example, to pick up corporate debt at double the rates of 18 months ago (5.5% to 6.5%) without taking on greater risk.”
• Capital Group’s fixed income portfolio manager Pramod Atluri believes yields may hover in the range of 3.5% to 5.5%, which were considered normal in the pre-financial crisis era.
• Mackenzie Investments recommends a broad underweight on equities and an overweight on bonds in their 2024 asset mix, expecting both a turnaround in the bond market and a return to the defensive utility so many of these assets are best known for.
• RBC GAM says: “We forecast that the policy rate will remain at 5% until mid-2024, and that the BOC will pivot to cutting rates in the third quarter of 2024, ultimately lowering the benchmark rate to 4.00% sometime within the next year. We forecast that Canadian 10-year government bonds will yield 3.0% at some point over the next 12 months.”
• Alliance Bernstein: “If your portfolio’s duration, or sensitivity to interest rates, has veered toward the ultrashort end, consider lengthening your portfolio’s duration. As the economy slows and interest rates decline, duration tends to benefit portfolios.”