Ninepoint Fixed Income Strategy Market View

June 6, 2019

Given all the volatility in rates and equity markets, we thought it might be a good idea to give you a quick update.

Since we last wrote about markets in our April commentary, a lot of things have happened or changed:

  1. US/China trade tensions are here to stay; it’s not just about the trade deficit, it is about technology and the US hegemony and making sure it stays like that. The tone on both sides has gone from bad to worse and we do not think that this will be solved any time soon. If they do impose tariffs on the last $300bn of Chinese imports, the average American’s purchasing power will be seriously impacted. Previous rounds of tariffs were on intermediate goods, not consumer products. Now the pain will be felt more strongly by the end consumer. The escalation of trade tensions will not only negatively impact China, it will hurt the US as well.

  2. After improving somewhat in March, Global growth data is weakening in Asia, Europe, Latin America and, more importantly, the US. For some reason Canadian data has come in strong, but given our correlation with the US, we should soon follow. Commodities in a slow growth environment will become particularly vulnerable and that will be problematic for Canada. Oil Prices are already down more than 20% from their April highs.

  3. Most recently, the straw that broke the camel’s back is the US threatening to impose tariffs on Mexico until they stop the migration from Central America to the US. Mexico was in the process of ratifying the new NAFTA when the US announced this. What this tells Mexico and the rest of the world, including us, is that it doesn’t matter what type of trade deal you strike with Trump, he can turn around the next day and rip it up. That makes it less likely that anyone else (China, Europe, India, etc) would want to waste their time negotiating with Trump on trade. Lastly, Mexico’s economy is very highly integrated with the US economy. Supply chains will be hurt and this will lead to increased uncertainty, higher inflation and lower GDP growth.

As the result of this, the Federal Reserve is now expected, by market participants, to cut rates at least 2 times this year. The big question is no longer if, but when that will happen. Some speculate that it could happen as soon as the July FOMC meeting. In a speech yesterday at a Fed event, Chairman Powell said that the FOMC would assess the impact of those trade developments and act in such a way as to extend the economic cycle as long as possible (i.e. cut rates if the outlook deteriorates). This hints that they want to see what happens (at the very least at the G20 summit late June) before making a move. We do not think that the Fed wants to cut rates too early, but it might become a necessity. Unfortunately, vindicating Trump’s recklessness.

The bond market has reacted quickly to all the above.The yield curve is now inverted by more than 20bps. Based on our recession model, this implies a 46% chance of a recession in the US 12 months from now. Of course this is simply a model, but it goes to show how quickly things have deteriorated.

Source: Ninepoint Partners

In this context, it still feels like equities and credit are living in a fantasy, acting as if a Fed rate cut is good for them. We strongly disagree. The Fed cuts rates because the economy is deteriorating, which is bad for earnings and multiples. Accordingly, previous historical episodes of rate cuts are associated with low equity returns and double the usual volatility.

From a portfolio positioning perspective we are preparing for the slowdown and potential of 2020 recession. We have continued to high grade the portfolio, sell down lower rated credit, add government bonds and extend duration.

As always, please reach out to us with any questions or comments. Happy to expand on topics of particular concern/interest.

The Bond Team: Mark, Etienne and Chris


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