January 13, 2009
Fixed Income Review and Outlook
Fourth Quarter 2008
Review
During the last
quarter of 2008, particularly later in the quarter, the dramatic monetary
interventions witnessed in the previous months began to have an impact on the
credit markets. The Fed drove down administered rates close to zero and has
made it very clear that it intends to keep them there for as long as necessary.
Moreover, other policy actions were being implemented through a massive
expansion of the Fed’s balance sheet. The central bank has been buying various
types of private debt instruments thus providing additional market support. As
a result, LIBOR yield spreads, commonly used as gauges of risk in the money
markets, shrank substantially over the period. All central banks around the
world, including Canada’s continued to ease significantly. With consumer
prices softening rapidly and commodity prices having literally collapsed,
inflation is not a primary concern. The negative impact of the financial crisis
on the world economy gathered momentum over the quarter, with many economic
indicators reaching critical levels. As a result, government interest rates
declined across the maturity curve, particularly in the US. However, corporate
yield spreads continued to rise before beginning to narrow very late in the
quarter. Due to the economic concerns, the liquidity in these instruments has
generally remained poor.
Interest Rate Levels (%) and Spreads (basis
points)
09/30/08 12/31/08
|
Sector |
3 mos. T.Bills |
5 year |
10 year |
Longs |
3 mos. T.Bills |
5 year |
10 year |
Longs |
|
Canada
U.S.
|
1.70
.90 |
3.10
2.90 |
3.71
3.76 |
4.19
4.25 |
.92
.14 |
1.84
1.55 |
2.87
2.21 |
3.64
2.67 |
|
Spread
US - Can. |
-80 |
-20 |
5 |
6 |
-78 |
-.29 |
-.66 |
-.97 |
|
Ontario
Ont. - Can. |
|
3.95
85 |
4.61
90 |
5.03
84 |
|
2.98
114 |
4.25
138 |
4.85
121 |
|
Financials
Fin.
- Can. |
|
5.25
215 |
6.00
234 |
6.89
270 |
|
4.10
226 |
5.25
238 |
6.25
261 |
Outlook
There is a growing consensus among
market observers that economic activity will continue weakening in the early
months of 2009 and begin to improve in the second half, benefiting from both the
monetary easing and the planned increases in government spending in most
countries. This is a reasonable expectation when one looks at past cycles of
the last 50 years. The obvious risk to this forecast is that, given the
unprecedented nature of the events of the last year and the extent of the
de-leveraging currently under way, normal patterns of recovery may not
materialize. If this consensus proves wrong, it will be by being too
optimistic. In that case, government bonds could rally further while, in a
normal recovery scenario, they would experience price declines. However, in
either case, corporate bonds should do very well, as there is much room for
yield spreads to narrow, especially for corporations with strong balance sheets
and good cash flows. This is particularly true in the US where the “switch of a
generation” is at hand: 5 year investment grade corporate bonds (BBB) can be
purchased at a yield around 7.5% while similarly dated Treasuries are yielding
less than 1.5%. Composite high yield indexes are yielding about 16%! The market
situation in Canada is similar, albeit featuring somewhat lower yield spreads,
and a narrowing in US corporate spreads will be reflected here as well. Canadian
fixed income portfolios should continue to be heavily weighted in corporate
securities.
Contact Mick Mitrovic:
Canaccord Capital - BCE Place, 161 Bay St., Suite 2900
P.O. Box 516, Toronto, ON, M5J 2S1
Tel: (416) 867-2033 | Cell: (416) 985-6422
Toll Free: 1-800-382-9280 | Fax: (416) 947-8328 |
