'Now is not the time to ignore bonds'

In a move largely anticipated by the market, the Bank of Canada on Wednesday raised its key interest rate by a quarter of a percentage point, simultaneously putting to rest questions about further hikes — in the near term at least, notes Philip Petursson, chief investment strategist at IG Wealth Management. His main takeaway for advisors and their portfolios? “Now is not the time to ignore bonds.”

“Canadian bond markets should be stable from here, because without the expectation that the Central Bank is going to raise rates further, it puts bonds in a more favourable light,” Petursson says, adding that although when looking at the futures market it’s still too early to factor in cuts, they’ll likely come in 2024 — but that could start to be priced into the bond markets at the end of this year, which is also beneficial to bond prices and bond market expectations. 

Bonds are especially attractive if the country is heading into a recession, as they would offset further equity market volatility, and while it’s still debatable if it will be a hard or soft landing Petursson believes Canada, and similarly the US, is headed towards a recession. Though there isn’t evidence of it in the economy as of yet, “you have the signs it is forthcoming.”

“This announcement is still consistent with that: the Bank of Canada doesn’t want to go too far and risk a damaging recession, but they’re comfortable with a mild economic contraction that eases inflation and the very tight labour market we’ve got right now,” Petursson says. “It’s in line with what they expect and what the market expects as well.”

Petursson also says that with inflation beginning to come down, IG Wealth Management thinks it’s realistic that it will be in the Bank of Canada’s target of around 3% by mid-year and another thing to consider is with the Bank of Canada signaling a pause, there’s less upside potential for the Loonie to appreciate relative to the US dollar. Though he doubts we’ll see much depreciation, “four to six months ago we felt there was much more upside to the Canadian dollar and downside risk to the US dollar, and that has largely gone away.” 

The extension of this, Petursson stresses, is that the Bank of Canada isn’t acting in a vacumn — they’ve made this move perhaps with a sense that the Federal Reserve is also nearing an end to their rate hiking cycle. That’s important because if the Fed pushes too far and the difference in interest rates continues to widen between Canada and the US, that’s more downward pressure on the Canadian dollar which is actually inflationary.

“Ultimately this was exactly what we expected: this will be the last hike — for a while anyway — as they assess the impact of the previous hikes, and even the fact the Bank fairly explicitly said they’re pausing was in line with our expectations,” says Petursson. “We can also use this as a guide to what the Fed might do — and that is that they’re much closer to a pause now as well.”