Dylan Bredo shares what he’s telling clients as rates offer lower coupons, but stay stable
Each month at WP, we offer a slate of articles and content pieces that go deep on a particular topic. This month, we're focusing on fixed income.
For the sixth successive time, the Bank of Canada held interest rates steady at 2.25 per cent yesterday. The decision cements a relatively long period of interest rate stability in the BoC’s history, with rates sitting in a slightly accommodative zone as the bank weighs inflation rates above target against sluggish economic growth and the overhangs of US tariff threats. For advisors looking at their fixed income allocations, the rate they may be getting on Canadian bonds is far from ideal, but the stability alone is something to work with.
That’s the view taken by Dylan Bredo, Partner at Bilyk Financial in Vegreville, AB. He outlined how he sees risks to that stability and whether the potential for either an inflation or a growth shock could shift interest rates one way or another. He highlighted some of the initial bond market reactions to yesterday’s decisions and outlined how he is approaching fixed income allocations and client communication in this market environment.
“We're seeing that core inflation number stay close to target, it's telling us that this is a supply shock. It's not an overheating economy. So raising rates wouldn't actually fix the problem. It would actually do the opposite. It would slow down and act on an already fragile growth economy. So the rate decision to us made sense,” Bredo says. “one thing worth flagging based on the decision is what we saw after the release. We saw bond yields and the loony both tick up a little bit. That tells us that the market's read on the tone was more cautious on inflation than what the market had priced in. Not a hawkish surprise, but a nudge towards ‘don't expect rate cuts anytime soon.’ A small move, but if it's the story that while the bank held the underlying, they're going to be watching it very, very closely.”
What stable at 2.25 per cent means for fixed income allocations
Bredo accepts that rates sitting on the low end of normal leaves income-focused clients, especially retirees, in a more challenging spot. People who might have enjoyed strong returns from their fixed income allocations at the peak of interest rates in 2023 are now being forced to look either further out on the curve or down in credit quality. Both options could involve risks a client can’t tolerate. The temptation, Bredo says, can be to sit in cash and lose ground to inflation, or to add risk and chase yield.
While current rates might put some clients in a tight spot, Bredo frames this as an opportunity for advisors to plan. With rates now apparently settled into a safe spot for the Bank of Canada, advisors can work with their clients on a more stable expectation of what they will earn, which he prefers to the moving targets that advisors had to chase in the post-COVID interest rate hiking and cutting cycle.
With that stability, Bredo says that advisors can add in those other sources of yield, be that maturity or credit rating, slowly and in ways that suit client risk tolerance.
Where to allocate and how to explain it
He still prefers to stay on the shorter end of the yield curve to avoid some of the macro risks that overhang long-duration Canadian bonds. He adds that longer-dated Canadian bonds carry a heavy correlation to global bond markets, so even if Canada exercises relative fiscal restraint compared to its peers, a bond market reaction to sovereign debt levels in the US or UK, for example, could see a serious downturn in the value of long-dated Canadian bonds as well. Beyond the risk, that’s also a deeply difficult phenomenon to explain to clients.
Canadian credit, Bredo says, has been an interesting place for a few years now. While he sees a lot of opportunity in the investment grade space, he notes that Canadian high yield credit has been carrying a lot of tariff risk for the past 16 months. There are also risks emerging for Canadian credit and the wider Canadian economy in the fact that business investment has now fallen for five quarters in a row. There is also the risk that yet more energy price spikes could emerge from the Middle East, putting further upward pressure on rates. All of those risks, he says, should be on the radar and managed by advisors and the asset managers they work with and communicating that clearly to their clients.
“Our message right now is there's no perfect moment, because that moment might not come the way people expect. It's a good time to put money to work and lock in decent income. We always steer towards quality,” Bredo says. “Our job is to protect capital and protect the money that our clients have worked so hard to build. So that means steering toward quality, steering toward maturities that aren't piling into one date, and reminding them that parking everything in short-term cash isn't as rewarding as it was a few years ago.”
