Although the Bank of Canada will keep short term interest rates very low, it has already started paring back on its purchases of government bonds, and we think it will probably further reduce its quantitative easing in the first quarter of 2021. Consequently, we believe bond yields for all but the shortest maturities are likely to rise in the coming months, and we have started reducing portfolio durations in anticipation of this. We have also structured the portfolios to benefit from a steepening yield curve because long term yields have greater freedom to rise with the Bank of Canada holding very short term yields steady.

Financial markets are already starting to discount a robust economic recovery occurring once sufficient numbers of people have been vaccinated. In the bond market, this is particularly evident in corporate yield spreads that are currently tighter that the average of the last decade despite the current uncertainty. However, as one of our favourite economists has noted: “The risk is that the eventual rebound on the services side underwhelms and prompts a rethink.” In other words, so much good news has been priced in that the risk of disappointment is high. If that happens, corporate yield spreads will widen and the sector will underperform. Consequently, we are focussing on higher quality credits and maintaining reduced exposure to BBB-rated issues. Should spreads narrow further, we will consider reducing the allocation to the corporate sector.

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