Global bond markets had the strongest month of performance dating back to the 2008 financial crisis. The Canadian bond market soared 4.5%, while the U.S. bond market rallied 4.6% in November. These are the largest monthly gains since December of 2008, the depths of the great financial recession over 15 years ago. What’s driving bond prices higher? Simply put, interest rates are trending lower. As benchmarks, the Canadian 10-year interest rate and U.S. 10-year interest rates peaked at 4.3% and 5.0%, respectively, in October. Over the last month, both rates have moved lower by 0.8%. When interest rates move lower, bond prices move higher.
In our recent market insight, “The Rally that Investors Might Miss,” we discussed our optimistic outlook on the bond market over the next 12 months. While retail investors who prefer absolute certainty have flocked to high-interest savings accounts and GICs, they risk not participating in a fixed-income rally as interest rates trend lower. For some, the certainty of a fully protected principal is worth the opportunity cost, fair enough. However, Matco believes that a properly positioned fixed-income strategy can offer similar protection to GICs, with healthy income, greater upside potential and a more productive hedge to equity market risk.
So, what fueled the recent rally, and is it over? November’s strong bond performance was fueled by increased anticipation that the Bank of Canada and the U.S. Federal Reserve are not only done hiking their overnight interest rates but that they will begin cutting them next year. As discussed in our recent market insight, “Fixed Income: The Swap Market vs. The Fed,” markets are currently pricing in a 0.5% to 1.0% reduction of overnight interest rates in 2024. Although the magnitude and timing of these cuts are great water cooler debates among investors, we’re less concerned. Matco believes that the direction is lower, the timing is uncertain, and that pro-active portfolio positioning is the key. Within Matco’s fixed income fund, we extended our Fund’s duration (sensitivity to interest rates) throughout 2023 while upgrading the credit quality of our portfolio. Both positioning adjustments will benefit the portfolio when rate cuts occur.
We’re humble enough to understand that any outlook accompanies uncertainty. The recent bond rally indicates that the market has begun pricing in the pending rate cuts. The sentiment over rate cuts will ebb and flow, as will the bond market rally. What’s critical from our perspective is taking a long-term view; lower interest rates are on the horizon, and although it won’t be a straight line getting there, it never is. As investment managers, we aim to understand risk and return outcomes based on current and anticipated economic data. We are the most constructive we’ve been on the fixed-income asset class in over five years and are positioned to participate when the rally continues.
