Fixed Income

The Fixed Income Market: Mid-Year Update

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Head Fixed Income Trader Harvey Libby joins the podcast to provide an update on the fixed income market and opportunities therein, including:

  • What is the current outlook for bond yields in the next year?
  • After-tax yields, why they are important.
  • Any other opportunities that you see in the market right now?

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Chris: Hello and welcome to the Advantaged Investor, a Raymond James Limited podcast. A podcast that provides perspective for Canadian investors who want to remain knowledgeable, informed, and focused on long-term success. We are recording this on May 29, 2023. I'm Chris Cooksey from the Raymond James Corporate Communications and Marketing Department. I'm speaking with Head Trader for fixed income, Harvey Libby. Harvey's been on the podcast many times before and he is returning today to give us an update on the fixed income market and the opportunities therein. Harvey, welcome back. Hope you are doing well.

Harvey: Thanks Chris. Yes, I definitely am doing well. It's been a very busy time for fixed income markets, so it's been fantastic on our front.

Chris: It's got to be nice when people remember you exist though, right?

Harvey: Oh, big time for 10 years nobody knew who I was.

Chris: Yeah, we have a lot to get to so we'll jump right in. Maybe just start with the current outlook for bond yields over the next little bit, say the next year or so.

Harvey: Basically it's the same as it's been for the last six months. Everyone's calling for slightly lower rates going forward. Just slightly lower. They keep pushing it out a bit, pushing out how long it'll take for rates to start going down. But basically, for a one year time horizon, the shorter term rates should drive down further than longer term.

If you look at economist views on the Street a three month T-bill, which is currently around 4.6%, should go down to about three and a quarter, which is a big move. Or sorry, a 3.8, which is still a big move. And then as I said, three and a quarter, that's two years out. Currently at 4.3%, they're thinking it's going to go around 3.2%.

So 110 basis points lower than it is right now for 10 years. It's currently 3.3% to 2 81%. So we're looking above 50 basis points and 30 years from 3.28% as it is currently to about 2.95%. So the shorter term should get affected. A lot more drastically than the longer term going out.

It's s kind of crazy actually, Chris. It's been a rollercoaster in our fixed income market for the last, well ever since January 1, basically one month we'll have a big rally in prices and a decrease in yields. The next months will have a big drop in prices and increase in yields, and it just keeps going back and forth, back and forth, back and forth.

Right now futures are actually implying that there might be a one or two rate hikes in Canada by the end of the year, but two weeks ago we thought there would be cuts by the end of the year. So, my current view is there might be one more hike coming in Canada, but it'll only affect the really short term rates like the three month rates. And going forward, there'll be a lot of just them stalling or them not just staying pat with their rates and seeing what happens with inflation.

Chris: So, safe to say that it's really a battle of the sides right now to see who should take control.

Harvey: Yeah, big time. It seems to be a number gets printed – CPI gets printed, or another inflation number will get printed, and people will just jump on that side and then jump back and forth and back and forth. It's been crazy and that's what's been happening in the market basically.

Chris: So if we're thinking between governments whether they're federal, provincial versus corporates, is the story the same or is there a bit of a divergent story between corporates and governments Right now?

Harvey: I don't think it's changed much from like six months ago. I think opportunities are a lot better on the corporate front just because of absolute yields. There hasn't been a big divergence in you know divergence of corporate yields widening out drastically because of these inflation concerns that really hasn't happened.

They have widened slightly. But not much. You're still getting paid a lot more to be buying a corporate bond than you are a government in this market right now. And in Canada especially, you'll take a look at most corporate issue or issuers in Canada are the banks and you know what? They're doing okay. They're doing all right. They missed their numbers last week, but they're all still making money, and they're making lots of money.

Chris: It's a loan provisions too, right?

Harvey: Exactly. They have done that drastically in the last couple of reports, right?

Chris: So the banks are still in good order. We don't have to worry about that in Canada.

Harvey: not in Canada.

Chris: Now you have been a prolific emailer internally. Currently sending out all sorts of offerings and obviously what's really important, I guess in a lot of ways, is after tax yields, because it's sort of the money you get to keep, I guess.

And I would invite listeners to check out the last edition of Insights and Strategies. You have an article in there, but maybe just give us the old 411 on how after tax yields et cetera, are working.

Harvey: Okay. Yeah, we've been putting out a lot of stuff on after tax because it is the new yield, as I like to refer to it as, because people are going out and I'm getting a lot of people on my friends and other colleagues and that saying, well, I'm just going to go buy a one year GIC it, you know, it's 5% or it's 4 85. I think it just went back up to 5% this week or late last week. You look at that though, and a 5% GIC for one year. Is all interest income in a taxable account. You have to remember, I'm only talking taxable accounts here. I'm not talking to your RRSP. If it's an RRSP, just go buy the best rate, best yield you can.

Chris Whatever suits your needs in talking to your advisor. Let's make sure our friends in compliance understand.

Harvey: Always talk to your advisor. And then they should buy, you know, the best yield that you can get at. At your comfort level. But when you're looking at something like this in a taxable account, you're getting 5% on a GIC, well, that's all interest income right now.

There are opportunities in the market, whether it be a corporate or even a Canada bond, so there's one Canada bond out there that is just less than one year. It's only yielding about 4.40% or 4.45%, compared to a 5% on a GIC, but its after tax yield is dramatically higher because of the discount factor of the bond.

So the bond only has a coupon rate, a 0.25% on it. So not like 1% less 0.25%. So it is trading at a discount to 100 and it'll mature at a 100. So it's trading at $96.55 in less than a year, and 11 months, it's going to mature at a hundred. So you're going to get $3.45 back in capital gain. Plus you're going to get interest income from the 0.25 until maturity, but most of your return is that capital gain, the 3.45%, right? That is where your after tax yield becomes apparent, and it basically works out to an equivalent yield. You would have to be able to buy a GIC at around 6.50% or 6.55% for it to be equivalent of this. This bond right now, this bond is a Canada.

You have no problems with Canada. It's AAA rate. It's the best quality you're ever going to get in the world. Also has a secondary market, so if you have any trouble, where GICs, you're locked in for a year, you know something comes up, you can't get out of it. Canada, you can sell it if there is a problem in the market. Or sorry, if there's a problem with your finances or whatever else need, you need the funds, you can sell it right away. Most liquid market in Canada, and there's also opportunities on the corporate level if you want to take a little bit more risk. There is corporates out there that you can get all the way up to a 7.1% equivalent GIC and you go and buy yourself a corporate bond. You know, and it's been such a good thing for our financial advisors to go out and get new money and to get new prospects and to bring in people and well, you know, show everyone we know what we're doing and just don't go buy the best yield out there. There's a little bit more to it, and that's why you should be talking to an investment advisor.

Chris: And as we talked about off the start, it's been since January, as you mentioned. It's been a while since there's been this many options in the fixed income space to, cover the needs. Before it was probably structured and, well, this is what our option is here, take this. But now there's a plethora, if I can throw in that word, of options available.

Chris: There you go. Now let's just finish off with, you mentioned the word opportunity, but what other opportunities are you seeing out there in the markets right now? Or, that you can look into your magic crystal ball and tell us?

Harvey: There's probably three things I want to talk about. First thing, just talking about GICs again the other. The other thing with GICs right now, GICs sometimes lag the market. We're going to be talking about the next Insights and Strategies.

GICs will lag the market. If rates if the fixed income market and yields are going up higher in a dramatic form over, let's say a, a week or two. GIC rates will always take time to adjust and it's, it's good sometimes and it's bad sometimes. Right now it's bad.

Because rates are lower than they should be. Yeah. GIC rates should be adjusted higher. They're starting to like I said, I think last week, the GIC one year rate was 4 85%. I think now one issuer is at 5%. So you have to look out for this. So if you go to your financial advisor, say, you know what, I would, I just want to buy a five year GIC.

Well, the best five-year GIC on our rates this morning was 4.54%. Well, 4.54%, you could go and buy a bank bond. Any of the Canadian big five bank bonds and it'll yield more. For one thing, if it's a taxable account, like we said before, you will get an after-tax equivalent yield a little bit better because they're all of them are at a discount right now.

And for another thing, you'll pick up about 20 or 25 basis points in yield, and you'll also go from a GIC where you'll be locked in for five years to something you can sell in the market. So there's, there's a lot of different goods with that. So, you know, just before you barge into buying a GIC talk to your financial advisor, there is other opportunities there.

The next thing in the market right now is strip coupons. There's a lot of stripped coupons out there. Basically, they've taken a bond and they've stripped off the interest payments and they sell the interest payments as a separate entity. They're called strip coupons. They traded a discount to par, so they're, they're only good to be quite honest in a registered account.

So if you're looking for something for a registered account, they're perfect. You'll buy them at 80 cents on the dollar, 90 cents on the dollar, depending on term, and they'll mature at a hundred dollars and the absolute yields are great on these things. They haven't been around very much, but there are some in the market right now.

And when you do get a chance to buy some of those, they're very good for your RRSP especially. You just buy 'em, hold them, let 'em, sit there to maturity and that's it. The last thing I would say is just for people to keep thinking about extending term. I know it's a hard, it's very hard to think of extending term when you've got an inverted yield environment or an inverted yield curve. When rates are higher in the short term, you tend to just want to put your money short term, but, just looking at where they're projecting rates out, you know, one or two years, you know, your one year stuff's going to mature. You're not going to be able to reinvest at the same rates that you can right now for 3, 4, 5 years out. So take some of your money. And extend term with it, which the best way is to buy a ladder as we always talk about, right? The safest way to smooth, the smoothest ride. Smoothest ride every year. You take an irregular sloping yield curve rates will be higher out the long end.

So something matures to the short end. You go, you buy something in longer term and you just keep rolling it like that. It's a no-brainer. It's the way to go. But you have to just say to yourself, listen, I know rates are like really good in the short end, and I'm not saying don't buy stuff in the short end, because rates are so attractive. But it's important to try to get yourself to extend term a bit to take advantage of these, because we don't know how long these are going to be around these good rates. You know and that's probably the three things I would suggest in this market right now.

Chris: Awesome. Well I want to thank you very much for taking the time today, Harvey. Really appreciate it and look forward to having you back in the future.

Harvey: Well, thank you.

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