Fixed Income Viewpoint
Benchmark Barometer – April 2014
Yields March Higher
The FTSE TMX Canada (formerly DEX) Universe Bond In- dex returned -0.19% in March, chipping away at the near 3% return registered through the first two months of the year. The loss was led by Provincials (at -0.48%) and Longs at (-0.41%), with their intersection resulting in a sub-sector leading loss of 0.72% for Long Provincials. However, apart from the smallest of losses for the Mid-Corporate A subsector (-0.01%), the entire Corporate sector was a sea of positive returns, which sailed as high as +0.65% for Long BBB Corporates. Indeed, the return differential between the “riskiest” and “safest” long bonds was more than a percentage point (long Canadas were -0.43%), emphasizing the power of supply-demand dynamics to buck the return-sapping impact of rising yields. The paucity of corporate supply during the first two months of the year created sufficient pent-up demand to not only easily digest a hefty new issue docket in March, but also cause most credit spreads to compress.
Benchmark Government of Canada yields rose along the curve, topping 10 basis points in the 5- to 7-year segment. The move reflected an even more pronounced “bear bowing” in the U.S. Treasury market. South of the border, 3- to 5-year yield rises topped 20 basis points but, interestingly, U.S. long bonds man- aged to rally during the month (yields down 3 basis points). These moves reflected the shift in Fed policy on March 19.
The FOMC abandoned the thresholds for inflation and the unemployment rates and, in doing so, afforded itself increased policy flexibility on two fronts. First, there’s the flexibility not to tighten if the jobless rate continues to fall. The Fed was already asserting this flexibility with respect to the 6.5% threshold but they now no longer have to explain why. Second, there’s the flexibility to tighten even if inflation remains low. The latter
Table 1.1: FTSE TMX Canada (formerly DEX) Universe Bond Index March 2014 Total Returns
Source: PC Bond, a business unit of TMX Group Inc. As of March 31, 2014
Jason Parker, CFA
BMO Nesbitt Burns Inc. jason.parker@bmo.com (416) 359-5410
Michael Gregory, CFA
BMO Nesbitt Burns Inc. michael.gregory@bmo.com (312) 845-5025/(416) 359-4747
was the reason why Minneapolis Fed President Kocherlakota dissented. Note that the FOMC’s own projections for the fed funds target showed an additional 10 to 15 basis points of rate hikes in 2015 and an earlier start to tightening (all else equal), compared with December’s polling. Then came Janet Yellen’s press conference.
When questioned about what “considerable” meant in the FOMC’s forward guidance (maintaining current rates “for a considerable time after the asset purchase program ends”), Ms. Yellen mused “something on the order of around six months or that type of thing.” The market quickly set its countdown- to-liftoff clock. At the current $10-billion-per-meeting tapering pace, asset purchases would end in either October (if the final taper were upped to $15 billion, which is our base case) or De- cember (if the final taper were left at $5 billion). This potentially set policy rate liftoff for either the April or June meeting, which was earlier than the market was initially contemplating.
Table 1.2: FTSE TMX Canada (formerly DEX) Universe Bond Index Year-to-Date Total Returns
Source: PC Bond, a business unit of TMX Group Inc. As of March 31, 2014
Sector Short Mid Long Broad
Composite
1.06%
3.22%
5.12%
2.77%
All Government
0.86%
2.99%
4.84%
2.68%
Canada Agencies Provincials Municipals
0.67% 0.94% 1.14% 1.34%
2.99% 3.09% 2.97% 3.03%
4.93% 5.18% 4.76% 5.37%
2.24% 1.73% 3.42% 3.23%
All Corporates
1.39%
3.85%
6.06%
2.95%
Corporate AA Corporate A Corporate BBB
1.31% 1.35% 1.65%
3.60% 3.52% 4.16%
5.51% 5.83% 6.56%
1.58% 3.35% 3.80%
Sector Short Mid Long Broad
Composite
-0.01%
-0.24%
-0.41%
-0.19%
All Government
-0.07%
-0.37%
-0.62%
-0.33%
Canada Agencies Provincials Municipals
-0.05% -0.10% -0.07% -0.04%
-0.29% -0.47% -0.39% -0.25%
-0.43% -0.54% -0.72% -0.56%
-0.20% -0.24% -0.48% -0.29%
All Corporates
0.07%
0.11%
0.29%
0.13%
Corporate AA Corporate A Corporate BBB
0.01% 0.11% 0.17%
0.02% -0.01% 0.23%
0.08% 0.11% 0.65%
0.01% 0.08% 0.31%