Concerns about indebted Canadian households struggling with rising borrowing costs are everywhere, but one analyst believes that we’re headed for a reversal – lower rates and borrowing costs – in 2019.
There’s been oceans of sell-side research published to explain the global market volatility of recent weeks. One of the most arresting statements was from CIBC’s head of North American rates strategy, Ian Pollick, who said that the price of one- to three-year government bonds “is going to be one of the best macro trades around, but that is a 2019 story.”
Bond prices move in the opposite direction of yields, so if owning shorter-term bonds is going to be a great trade in 2019, bond prices are going up and yields lower.
Mr. Pollick’s forecast is directly opposed to the consensus view that domestic interest rates are headed inexorably higher, thanks to the Bank of Canada’s stated monetary tightening intentions.
Mr. Pollick says that the central bank is closer to the end of its tightening cycle than the market believes. Options markets indicate expectations for Bank of Canada policy rate of 2.5 per cent by the end of 2019. This would require, however, that Canada’s current strong economic momentum continues at the same pace. Otherwise, bank Governor Stephen Poloz’s rate hikes could send the economy into recession.
A recession, or at least sharply lower gross domestic product expansion, is a legitimate concern. In Mr. Pollick’s words, “there is a greater sensitivity of the economy to higher administered rates than at any other point in history given the starting point of [high] household leverage.” In other words, the record levels of consumer debt means that increases in borrowing costs will hit the economy harder, and more quickly than in previous periods.
An about-face in market expectations – from higher bond yields and interest rates to CIBC’s scenario of falling rates – would have significant implications for asset prices. For one, and perhaps most important, the dividend-bearing equities that have underperformed as yields have climbed in 2018 would regain their footing. The dividend yields would again start to look attractive relative to declining bond yields.
Correlation analysis using the past decade of market data (not shown) highlight consumer staples, telecommunications, REITs and utilities as the equity sectors most likely to outperform as shorter-term bond yields fall.
Scott Barlow, Globe Investor’s in-house market strategist, writes exclusively for our subscribers at Inside the Market.
Scott Barlow