Investment strategist speaks out on what ratings agency's surprise move means for fixed income portfolios
Earlier this month, independent ratings agency Fitch surprised markets by downgrading the credit rating of the U.S. from AA+ to AAA.
In a statement explaining its decision, the agency noted a “steady deterioration” in standards of governance at the U.S. Treasury over the last 20 years. The downgrade, it said, also reflects an anticipated fiscal deterioration over the next three years, as well as a “high and growing general government debt burden.”
Ashish Utarid, AVP Investment Strategy at IG Wealth Management, said the move was unexpected, but it doesn’t change his firm’s market view or investment strategy.
“What it does have is an impact on investor sentiment,” Utarid told Wealth Professional in an interview. “In general, we would put the importance of the downgrade is the same box as the US election, or what we recently went through with the debt ceiling crisis. These are headline events, but don't necessarily alter the investment outcomes.”
US bonds still a pillar of strength
US-issued sovereign debt is widely considered highly secure because of its economy’s size and relative stability. The credit rating downgrade by Fitch might raise a question mark over that for some – but not for Utarid.
“The U.S. Treasury market remains one of the safest places to park your risk-free cash,” he says. “There's very few alternatives that offer that type of security and protection so we're very confident that the U.S. remains in a position of strength.”
Looking broadly across the fixed income market, Utarid says yields are at attractive levels – in some cases, pushing levels not seen in decades. With attractive income and the potential to provide ballast against equity volatility in times of market stress, he says bonds’ portfolio diversification capabilities are still there, though investor demand for high-interest savings vehicles including GICs and high-interest savings accounts has risen over the past 18 months.
“We believe investors should not shy away from those potential [U.S.] bond offers. We’re unlikely to see a repeat of last year's bond market performance,” he says. “A combination of short-term cash-like investments, and longer-term bonds should serve investors really well in the in the current interest rate environment.”
No fallout for Canadian banks
Any negative ripple effects from Fitch’s U.S. credit rating downgrade, Utarid says, shouldn’t reach Canadian banks within the foreseeable future as their business models are very distinct from the U.S. system.
While Canada’s Big Six banks have seen a slight decline in personal deposits – around 12% from their peak in March last year, though still $125 million higher than pre-COVID levels – he says they remain well-capitalized as the assets pulled from deposit accounts have tended to move into short-term products like GICs.
Utarid also offered some thoughts on the US Federal Reserve and Bank of Canada’s monetary policy trajectories, which he believes are near their peak. US CPI data last week showed inflation has come down to 3.2%, significantly down from its two-decade high of 9.1% last year.
“To get from 3% to 2% is going to require a little bit more patience from central banks and consumers,” he says. “US CPI data showed the price of durable goods declined significantly by 1.4% which is going to drive inflation down further. That suggests the US Fed, and ultimately the Bank of Canada are unlikely to raise rates for the remainder of this year, and potentially cut in mid-2024.”
Against that backdrop, IG Wealth expects current levels of interest rates to persist for the short term, allowing the economy to slow down sufficiently for central banks to be satisfied that the inflation wildfire has been contained.
That light at the end of the tunnel might not be immediately evident to investors still shell-shocked from the hits their portfolios have taken since last year. While that might make some more biased to flinch at fearful economic and market headlines, Utarid is underscoring the importance of a long-term view.
“Although inflation was at record highs for quite some time, it's come down significantly. Investors must understand that they need to be invested over the long term and not trying to time the markets,” he says. “We appreciate investors must filter out a lot of noise and getting professional advice is necessary, now more than ever.”
