Where are interest rates going?
With interest rates at 50-year lows, many investors are wondering if interest rates are going to go up. For Canadians who hold debt, obviously they hope that interest rates stay low. For investors, especially conservative investors, they hope interest rates go back up to double digits so they can get better guaranteed returns.
I asked three fixed income mangers to help me answer this question.
Geoff Wilson, Vice President of TD Asset Management Fixed Income Team
For Wilson, when looking at interest rates, it is important to start with the big picture. From an inflation perspective, Wilson says “It is important to the government that they send a message to Canadians about where they see inflation.” He feels that governments are committed to trying to keep inflation in a trading band between 1% to 3%. In addition, Wilson feels that the Canadian government has been and will be committed to fiscal management and maintaining budget surpluses.
Part of the contributing factor for lower bond yields is that the debt has moved from being in the hands of international investors to domestic investors, which ultimately gives us more control. According to Wilson, “At one time, 30% of our debt was in the hands of foreigners while today, that number has dropped to 17%.”
All of these factors influence the premium over inflation. Wilson feels, “Our expectations are that bond premiums will stay within a reasonable band. That is probably 2% to 3% over inflation. If inflation ranges between 1% to 3%, we expect that the nominal yield on bonds will be 4% to 5%.”
Randy LeClair, Manager of the AIC bond fund and the AIC Total Yield Class Fund
LeClair believes, “Looking at the longer-term, say 3 to 5 years out, interest rates will continue their trend in a downward direction. The 30-year Government of Canada bond (now around 5.00%) will trade in a range between 3.0% and 4.0%, similar to where it was in the period of 1945 to 1958. This will happen primarily of a supply-demand imbalance. The supply of outstanding bonds is limited (or even declining), while the demand for these securities in sharply increasing due to the aging Baby Boomer generation. It is really the reverse of what happened in the 1960’s, 1970’s and 1980’s.
In the shorter term, looking 6 to 12 months forward, one of the big worries is when central banks will start to increase short-term interest rates. We refer to this as the “tightening” part of the economic cycle. It is when central banks, like the Bank of Canada, take their foot off of the gas and step on the brake. This is given much attention in the media, and it is also a dangerous time for bond fund managers.”
Chris Kresic, Senior Vice President, investments of Mackenzie Financial Corporation and is head of the fixed Income Team
“Our positioning of the fixed income portfolios remains cautious for the near term,” says Kresic. For the past two quarters, Kresic has been shortening the duration and moving towards shorter term bonds as opposed to longer-term bonds. We will be looking to reduce it further should healthy employment growth, a reduced output gap, or indications that the US dollar decline has become disorderly manifest itself. Otherwise our weighting in corporate bonds remains unchanged, as does the AA overall credit quality for the fund. We expect corporate bonds to continue to outperform government bonds in the short run but we look to reduce our corporate bond weighting once the Federal rate increases are felt to be imminent.
Right now the long bonds is about 5.15%. If it gets up to 6.0%, things will get interesting and we may look to change our strategy. If long bonds get down to 5.0%, then we would look to be even more defensive.
In the longer-term horizon, we could move to a more inflationary period, not necessarily like the 1970’s but there seems to be a shift in thinking by the government.”
The bottom line
It’s certainly no surprise to me that even the experts can have different opinions about the future. I certainly think we are at an interesting part of the cycle for bond investing since rates are so incredibly low. As you can see, some think rates will go up and some think rates will go down.
There are many reasons why you might consider the merit of using a bond fund like the funds offered by TD, AIC and Mackenzie Financial. They will diversify your holdings among different types of bonds like corporate bonds; government bonds, real return bonds and high yield bonds. They will also manage the spread of the yield curve and also make certain assumptions about interest rate movements and changes.
Investors should worry less about trying to time interest rates and markets and focus more on maintaining balanced portfolios that reflect their personal needs and objectives.