What is the big challenge for investors in Q2?

Fund manager casts his eye over bond yield risks and the issues facing the Canadian economy

What is the big challenge for investors in Q2?

The biggest challenge for investors in the next two quarters will be global interest rates and higher-than-anticipated bond yields.

That’s the view of fund manager Brian D’Costa, president of Algonquin Capital, who said that while Canada is not so far down the road as other economies with its rate hikes, the country has plenty to worry about with consumer debt, a lack of capital spending and trade issues.

D’Costa believes the US Federal Reserve rate-raising and quantitative easing programme will play a major role in influencing the bond market. On top of that, he expects the Central European Bank to begin its own QE exit programme later this year, while even the Bank of Japan has indicted it has started to think along the same lines.

D’Costa said: “If we get all the central banks just buying less, the balance in risk in the international bond market is of much higher yields than people anticipated.

“That’s the risk. It’s not that it will definitely happen, but in an environment where there are lots of factors leading to higher rates, taking out the biggest buyers in the history of the world? To me it’s a risk and something investors have to bear in mind.”

On the home front, D’Costa sees a mixed bag. He believes that with consumer consumption at something like 60%, and with mortgage rates higher and mortgage rules tightening, it’s hard to see how the consumer can have an impact on the Canadian economy.

However, while the country is at full capacity, he said a welcome fillip could be the minimum wage hike, which could add 0.2-0.3% to CPI and take inflation to 2%.

D’Costa said: “In a normal world all this suggests the bank is going to hike, but there are big issues. If the consumer isn’t expected to be able to expand consumption, then the bank, to continue GDP growth, really needs investment of capital spending and trade.”

The US corporate tax cut has “negated” to a large degree Canada’s advantage in that area, while the issues over oil pipelines leaves that space stagnant. Throw in trade, which includes a “creeping trade war” with the US, and D’Costa believes Canada has serious question marks moving forward.

He said: “When you add all that up you’d say that Canada is at best moving on time this year. Five- and 10-year yields will get dragged a bit higher if it’s right that international yields get higher. [But] we think you get a steeper yield curve in Canada.”

He added: “The biggest story for investors is interest rates. Rapidly moving interest rates will affect equities; that precipitated the meltdown of equities in February. But when it comes to putting money in the bond market, we think that short-dated bond funds in Canada will probably have a positive year because we don’t think the short end of the yield curve is going to get pushed a lot higher.

“Longer maturity bond funds are mixed. It’s going to be close to zero and the reason is the longer end of the yield curve is moving higher to some degree in sympathy with the US market.”