Mackenzie fixed income CIO outlines dynamics in the bond market now that have his firm recommending an overweight
Mackenzie Investments’ 2024 market outlook projects a slowdown in global growth, elevated geopolitical tensions, and an end to central bank hiking. Out of that forecast the company’s investment leaders have recommended a broad underweight on equities and an overweight on bonds in their 2024 asset mix, expecting both a turnaround in the bond market and a return to the defensive utility so many of these assets are best known for.
Steve Locke, Chief Investment Officer, fixed income & multi-asset strategies at Mackenzie, outlined why he is taking a more favourable view of the bond market. He explained why Mackenzie is forecasting slow growth, and what’s changed since the start of the year when similar forecasts proved to be in error. He outlined, as well, where specifically on fixed income markets the Mackenzie Investments team sees the greatest opportunity.
“Things have distinctly brightened for bonds compared to the last couple of years, where there were a lot of dark clouds with rising yields and rising interest rates, that’s improved in line with our monetary policy and economic outlook” Locke says. “On the flip side of that is the caution aspect. Bonds are often thought of as an asset class that helps protect investors during rough equity markets and rough times in the economy. They’ll have a lower volatility profile although that hasn’t always been the case in the past two years. We think going forward that will be true.
“From the point of view of safety and being able to get a reasonable rate of return on a portfolio, given the economic and monetary policy conditions we face right now, we’re recommending a slight overweight to bonds.”
The past two years of interest rate increases have raised yields and lowered prices across the broad bond universe, making it all look more attractive. However, picking the right assets will be crucial to overall success. Locke is particularly interested in investment grade corporate bonds, particularly Canadian corporate bonds. He notes that many of these bonds are paying 5.5%-6.5% yields, rates they haven’t paid in well over a decade. At the same time, these companies are traditionally viewed as high quality, without much leverage and with sustainable business models. The result is a low risk of default on high-yielding assets.
Underpinning Locke’s view is the broad consensus that central banks have ended their hiking cycle following news of slowing inflation. Over the past two years, interest rate increases have been the primary risk driver in bonds, resulting in significant losses and historically high levels of volatility. Now, however, Locke sees the greatest potential for risk emerging from credit risk. That area, a more traditional source of risk for fixed income investors, can be moderated with an appropriate asset mix.
Mackenzie’s forecast for 2024 rhymes somewhat with what many analysts predicted going into 2023: slowing growth, an end to rate hikes, and a shift away from equities. Instead, we got more rate hikes, volatility in bonds, and outperformance from expensive, higher-risk tech stocks. Much of the tend-bucking we saw this year, Locke says, came down to US and Canadian consumers weathering tightening far better than expected. Earnings came in stronger than predicted for a number of large and mega-cap companies as a result. Now, however, cracks are beginning to show in US and Canadian consumer data. Canadians are, in particular, more interest rate sensitive and Locke expects that the Bank of Canada will likely cut interest rates before the US Federal Reserve does.
The current debate among analysts appears less focused on whether growth will slow at all, but whether slowing growth will result in a recession — a hard landing — or if a recession can be averted — a soft landing. The answer to that question will likely set the tone of future central bank policy and, by extension, drive performance in the fixed income market. In a soft landing, Locke sees the potential for some central bank easing on interest rates once inflation falls closer to their target rates. That should bring bond yields down slightly on the front end of the yield curve, but it’s unlikely that rates will drop to anywhere near their pre-COVID levels. Some of that soft landing scenario, he says, is already priced into bond markets.
In a hard landing, the impact of a recession on jobs and households may be enough for central banks to cut interest rates more aggressively. While Locke, again, does not expect rates to fall to near-zero levels again, he thinks there would be lower rates and a more dramatic positive return for investment grade bonds.
Mackenzie’s 2024 outlook highlights just how much uncertainty there is currently among investors. Locke believes that in this environment, advisors can help address that uncertainty and fixed income assets can provide a level of stability and yield more akin to their historical norms.
“Clients are feeling uncertainty around markets. When we look at broad measures of sentiment, people are feeling uncertain because of their experience with inflation and because of what the bond market experienced in the past two years,” Locke says. “But the inflation story is getting better and coming down. Central bank reactions to fight inflation over the past two years have resulted in a much better profile as bond yields and monetary policy rates have found a higher zone to sit for the next few quarters. We’ll see how the economy progresses in 2024, but that [policy picture] is good news for a bond investor.”