Capital markets have had several high-impact events to contend with lately, from a large corporate insolvency to geopolitical uncertainty and rising inflation, but for bond managers at Canso Investment Counsel Ltd., the biggest concern remains aggressive action on interest rates.
“The invasion of Ukraine and the Evergrande insolvency are impacting asset prices to a degree, (but) the primary focus of financial markets remains the policy response, or lack thereof, of the world’s central banks in response to substantially higher than target inflation,” Canso says in its in its April 2022 Corporate Bond Newsletter.
Canadian government bond yields have moved up dramatically over the last 15 months, as the entire bond market moved higher in anticipation of aggressive near-term policy action by central banks.
“History books will show the official end of emergency monetary policy accommodation to offset the COVID-19 pandemic came on those dates in 2022. In reality, the recalibration of bond markets started well beforehand, in response to inflation, and in anticipation of central bank action,” the newsletter reads.
But those preemptive moves were followed by a promise of increasingly aggressive rate hikes by the U.S. Federal Reserve, which have done “little to calm jittery markets.”
For the Canadian corporate bond market, this all translated into the second-largest drawdown on record in the first quarter of 2022, with the longer duration Canadian Broad Index faring the worst.
High yield bonds declined for much of Q1 in the face of rising bond yields and outflows from the asset class, as well as limited new issuance.
The leveraged loan market was the top performing segment within fixed income in the first quarter, although Canso warns its bond managers “remain cautious on this market due to the underappreciated amount of credit risk, the likelihood defaults will rise along with interest rates and the reduced protections afforded by weakened covenant structures which will reduce recoveries in default scenarios.”
Overall, Canso says, it will be companies, countries and individuals that will bear the cost of higher administered rates and rapidly rising bond yields.
“The withdrawal of quantitative easing means less money in the economy … (set) against an uncertain inflationary backdrop … (while) the conflict in Ukraine, China’s real estate industry restructuring, and the enduring pandemic (all cast) a shadow over financial markets,” Canso says.
“In this environment, we are placing a premium on liquidity (and) favouring high quality. The temptation to reach for yield is always there – this is not the time.”
Read the full April 2022 Corporate Bond Newsletter.
The views and information expressed in this publication are for informational purposes only. Information in this publication is not intended to constitute legal, tax, securities or investment advice and is made available on an “as is” basis. Information in this presentation is subject to change without notice and Canso Investment Counsel Ltd. does not assume any duty to update any information herein. Certain information in this publication has been derived or obtained from sources believed to be trustworthy and/or reliable. Canso Investment Counsel Ltd. does not assume responsibility for the accuracy, currency, reliability or correctness of any such information.