If we are correct that a trade war is not likely, some of the recent equity market volatility should dissipate. As that happens, the flight-to-safety bid for bonds may fade and yields begin to rise again. That said, we recognize that other factors are contributing to the weakness in stocks, including valuations and privacy of personal data at tech companies. Should equities continue to decline, especially if the correction turns into a bear market, higher bond yields may be slower coming about. But we would remind readers that the stock market should not be used as an indicator of economic health. As the Nobel-prize winning economist Paul Samuelson once quipped: “The stock market has predicted nine of the past five recessions.”

Currently, the Canadian economy is operating at or close to full capacity. Extraordinary monetary stimulus in the form of ultra low interest rates seems unnecessary. Growth has slowed, however, from the robust pace of the first half of last year. If the Bank of Canada is to be believed, it will probably not raise interest rates at its April 18th announcement date, even though its rates are now below those of the Fed. Should the Bank not move this month, it seems likely that pressure will build on it to move at subsequent meetings, both from rising inflation and possibly reduced trade concerns. We expect bond yields will move higher in anticipation of a move by the Bank, so we are keeping portfolio durations defensively short of their benchmarks.

We have been reducing corporate sector allocation in recent months, because corporate yields spreads had narrowed to historically unattractive levels. Excluding floating rate notes (FRNs) and issues that will mature this year, the holdings of corporate bonds are only slightly higher than benchmark weight. With regard to the yield curve, we believe the flattening that has occurred in the last few months is overdone. Accordingly, we have structured portfolios to benefit from greater term differentials (i.e. a steepening of the yield curve).

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