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

Legal notes

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

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