New rate environment: why the status quo in fixed income could prove costly

31 July 2024 by National Bank

As the Bank of Canada has just cut for the second time this year its key rate again and is likely to do so again in the coming months, the status quo in fixed income could prove costly. Look at our historical chart to get a clearer picture!

Chart showing the outperformance of bonds once interest rate peaks were reached

Here are three lessons we can learn from looking in the rearview mirror.

1. Cash has a downside: From 1980 to today, bonds have outperformed short-term liquid investments in flat and falling rate environments. Cash is comfortable, with money market funds or certificates of deposit generally yielding more than 4% with little to no risk, but it might cost you if you linger too much in the easy zone.

2. The 80s are not repeating…but: The early 80s were a different time, with mortgages at 21.5%, GICs at 17.5%, and inflation close to 14%. Inflation and rates did rise recently, but we have returned to normal levels, and expecting yearly returns of 35% from bonds is unlikely. However, some bonds are currently trading at a discount to their par value, a phenomenon rarely seen since the 1980s.

Chart showing the concept of a discount bond that trades below its face value.

3. Rate volatility creates opportunities: Unprecedented volatility in bond markets has resulted in bonds trading at discounts to their par values offering a tax-efficient approach to generating after tax returns. For a long time, low uncertainty made choosing debt securities easier. The new environment of fluctuating rates is one that active management could benefit from. With maturing GICs and forecasted rate cuts expected to negatively impact their future returns.

With their five distinct maturities, the NBI Target Maturity Investment Grade Bond Funds are a reliable alternative for short term income.

Learn more about target maturity Funds and their key benefits

Bonds are defined by the FTSE Canada Universe Bond Index = FTSE Canada Universe Bond.
Short-term liquid investments are defined by the FTSE Canada 91 Day T-Bill Index = FTSE Canada 91 Day T-Bill.
In 1982, the annual return on FTSE Canada Universe Bonds was 35.36%.
Average annual performance of the FTSE Canada Universe Bond yearly vs. the FTSE Canada 91 Day T-Bill.
Sources:Bank of Canada, Statistics Canada, Bloomberg

Legal notes

The information and the data supplied in the present document, including those supplied by third parties, are considered accurate at the time of their printing and were obtained from sources which we considered reliable. We reserve the right to modify them without advance notice. This information and data are supplied as informative content only. No representation or guarantee, explicit or implicit, is made as for the exactness, the quality and the complete character of this information and these data. The opinions expressed are not to be construed as solicitation or offer to buy or sell shares mentioned herein and should not be considered as recommendations.

NBI Funds (the “Funds”) are offered by National Bank Investments Inc., a wholly owned subsidiary of National Bank of Canada. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus of the Funds before investing. The Funds’ securities are not insured by the Canada Deposit Insurance Corporation or by any other government deposit insurer. For money market funds, there can be no assurances that a fund will be able to maintain its net asset value per security at a constant amount or that the full amount of the investment in a fund will be returned. The Funds are not guaranteed, their values change frequently and past performance may not be repeated.

These index providers are included in this document: FTSE and Bloomberg. These companies are licensing their indices “as is”, make no warranties regarding same, do not guarantee the suitability, quality, accuracy, timeliness and/or completeness of their indices or any data included in, related to or derived therefrom, assume no liability in connection with their use and do not sponsor, endorse or recommend National Bank Investments Inc. or any of its products and services. The above index providers do not guarantee the accuracy of any index or blended benchmark model created by National Bank Investments Inc. using any of these indices. No responsibility or liability shall attach to any member of the Index Providers or their respective directors, officers, employees, partners or licensors for any errors or losses arising from the use of this publication or any information or data contained herein. In no event shall the above Index Providers be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, legal or other expenses, or losses (including, without limitation, lost revenues or profits and opportunity costs) arising out of or in connection with the use of the content, even if advised of the possibility of such damages.

The FTSE/TMX indices are trademarks of the LSE Group. Bloomberg® and its indices are service marks of Bloomberg Finance L.P. and its affiliates, including Bloomberg Index Services Limited (“BISL”), the administrator of the index (collectively, “Bloomberg”) and have been licenced for use for certain purposes by National Bank Investments Inc. (“NBI”). Bloomberg is not affiliated with NBI, and Bloomberg does not approve, endorse, review, or recommend NBI’s products. Bloomberg does not guarantee the timeliness, accurateness, or completeness of any data or information relating to NBI’s products.National Bank Investments Inc.© 2024. All rights reserved. Any reproduction, in whole or in part, is strictly prohibited without the prior written consent of National Bank Investments Inc.

® NATIONAL BANK INVESTMENTS is a registered trademark of National Bank of Canada, used under licence by National Bank Investments Inc.
National Bank Investments is a signatory of the United Nations-supported Principles for Responsible Investment, a member of Canada’s Responsible Investment Association, and a founding participant in the Climate Engagement Canada initiative.