In May, the preferred share market continued the strong rebound started in mid April after U.S. President Trump paused his April 2nd “reciprocal” tariffs on most countries for 90 days. In May, the reciprocal tariffs on imports from China were also paused. This led to optimism that a resolution of the trade war could be found. The resultant improvement in the economic outlook caused a strong rally in common equities and preferred shares. In contrast, the Canadian bond market narrowly avoided a third consecutive monthly decline in May as higher than expected inflation and a weak U.S. bond market caused Canadian bond prices to decline and yields to rise.

Preferred share performance was also helped when investors looked to reinvest the $600 million received from the RY.PR.J series redemption on May 26th. All types of preferred shares had positive average returns in the month, with rate reset and floating rate issues having returns of 6.1% and 6.3% respectively, while perpetual issues lagged at 3.6%. The S&P/TSX Preferred Share Index ended the month with a return of 5.05%.

Likely the most impactful Canadian economic data received in May was that concerning inflation. The removal of the consumer carbon tax in April caused the headline rate of CPI to fall to 1.7% from 2.3%. However, excluding energy, the pace of inflation accelerated. The core rates of inflation, of note, rose to 3.15% from 2.85% the previous month, which led bond yields to jump higher as expectations of additional rate cuts by the Bank of Canada were pushed further into the future. Other economic data received in the month were mixed. The unemployment rate rose to 6.9% from 6.7%, in part because of a rise in the participation rate, but also because job creation stalled with the tariff uncertainty. More positively, both housing starts, and retail sales were better than expected. On the last business day of the month, we learned Canadian GDP grew at a better than expected pace of 2.2%. However, the strength was due to a surge in exports and inventories ahead of the threatened U.S. tariffs. The uncertain environment has stalled domestic economic growth, which was reflected in GDP for the month of March increasing only 0.1%, and advance data suggested a similar increase in April.

In May, Brookfield Infrastructure Partners LP announced its intention to redeem the $125 million BIP.PR.A series, with a reset spread of 356 basis points. Early in the month, the firm had issued a $250 million 5.598% hybrid bond, with a reset spread of 271 basis points. Given the hybrid’s lower reset spread and the better tax treatment of interest payments, the redemption had been anticipated, therefore, and there was not a significant move in price on the news.

Also, in May, Pembina Pipeline Corp announced its intention to redeem the $200 million PPL.PR.S series, with a reset spread of 427 basis points. Given the large reset spread, the market had also been anticipating this redemption and there was not a significant move in price on the news. As this is being written, Pembina issued a $200 million 5.95% hybrid bond, with a reset spread in 10 years of 271 basis points. Also, as this is being written, Cenovus Energy Inc announced its intention to redeem the $ 150 million CVE.PR.G series with a reset spread of 352 basis points.  Investors will receive the $475 million from the three announced redemptions on June 30th.

During the month, three series of preferred shares reset their dividends. Dividend rates continue to reset significantly higher because the 5-year Canada bond yield is substantially higher than the pandemic levels of five years ago. Details of the resetting issue were as follows:

During the month, Enbridge Inc announced insufficient investor interest in making the switch to the floating rate series and all ENB.PF.E shares will be fixed rate ones for the next five years. Given that fixed rate dividend rates are currently higher than floating rate ones, investor interest in switching into floating rate issues has generally declined. However, Fortis Inc. announced that enough investors in both the FTS.PR.H fixed rate shares and the connected FTS.PR.I floating rate shares wanted to remain in their respective series, and both series will remain outstanding. Going forward there will be 7,902,614 FTS.PR.H shares and 2,097,386 FTS.PR.I shares.

During the month, the seven largest preferred share ETFs had an aggregate inflow totaling $17 million. This was the first monthly aggregate inflow since November 2023.

J. Zechner Associates Preferred Share Pooled Fund

In May, the fund returned 4.22%, which underperformed the S&P/TSX Preferred Share index. The shortfall was largely a function of security selection. The fund held relatively few issues with low reset spreads (i.e. less than 200 basis points) that had especially strong gains in the risk on environment in the month. In addition, the portfolio’s approximate 8% allocation to institutional preferred shares, which are not in the S&P/TSX Preferred Share Index, underperformed the index.

Portfolio activity during the month including selling the BMO.PR.E position above par with an approximate 5.4% yield to its next call date.  The proceeds were used to add a new position in SLF.PR.G with an approximate 6.1% current yield, as it was bought significantly below par. In addition, we used cash from dividend income to add a new position in the CIBC 6.369% institutional preferred share at a price below par and to increase the fund’s holding of BCE.PR.F.

Outlook and Strategy

The Bank of Canada is scheduled to announce its next decision on interest rates on June 4th. We expect the Bank will leave rates unchanged as the recent GDP data did not show sufficient weakness to require immediate monetary stimulus. In addition, the unexpected rise in inflationary pressure will probably make the Bank more cautious about lowering rates. While we do not see any likelihood that the Bank will raise interest rates over the balance of this year, the uncertain outcome of Trump’s threaten-and-postpone tariff antics mean future rate cuts are not a foregone conclusion. Over the next few months, we anticipate the uncertainty will continue to dampen economic activity in Canada and present a challenge to corporate profitability. However, we believe the portfolio is well diversified across creditworthy issuers that have paid their preferred share dividends during previous uncertain economic environments.

In May, the 5-year bond yield continued to be well above the extremely low level five years ago resulting in the three resetting issues increasing their dividend rates more than 230 basis points, and given that they trade below par, the increase in dividend yields was even greater. We expect this condition to continue for the next several months. In addition, the current coupon levels and reset spreads available to corporations in the hybrid bond market are making it economically advantageous to redeem high reset spread series which should continue to support preferred share performance.

Investors will receive $475 million from the BIP.PR.A, CVE.PR.G and PPL.PR.S series redemptions on June 30th, when they will likely be looking to reinvest the proceeds in other outstanding issues. Also, in the month of July there are two resetting bank issues, CM.PR.Q and TD.PF.D, totaling $650 million, which the market is anticipating will be redeemed. The issuers’ decisions should be announced in June.