The pace of the recovery was likely to slow even before the onset of the pandemic’s second wave. However, with the pace of infections and hospitalizations rising in many jurisdictions, the re imposition of social distancing restrictions and business closures is increasingly likely. At this time, we do not anticipate the full shutdown measures that occurred in March and April, but the recovery is likely to be a slow, grinding one rather than a rapid one. Even if a vaccine against the coronavirus is proven effective and safe before the end of the year (our fervent hope!), manufacture and administration of sufficient doses of the vaccine would probably take until mid-2021. Only then are social distancing restrictions likely to be fully lifted and a full economic recovery become possible.

The scale of the Bank of Canada’s quantitative easing programme is so large that it dwarfs other dynamic factors in the bond market. For example, during the second quarter, the Bank combined with some foreign investors purchased more Government of Canada bonds and Treasury Bills than were issued. Domestic investors were, in fact, faced with a reduced supply of Canada bonds notwithstanding the exploding fiscal deficit. Going forward, the government has shown no interest in paring back its spending and the Bank appears willing to keep funding the resultant deficits. As a result, the federal government is able to raise the necessary funds at extremely low cost. One wonders if the Bank will ever choose to reduce its QE without a concomitant reduction in the deficit. If so, the yields on Canada bonds, particularly for longer maturities will likely rise. If not, will the Bank have lost a measure of its independence? For now, we believe the Bank of Canada will leave short term interest rates anchored at roughly 0.25% and its buybacks of Canada bonds will keep bond yields within the trading range they have established since May. Eventually, we believe longer term bond yields will rise before short term ones as the Bank maintains its monetary easing. As a result, we are structuring the portfolios in anticipation of the yield curve steepening.

While corporate yield spreads widened slightly in September, we do not believe they are properly discounting the economic and financial risk in the current environment. We are concerned that personal and corporate bankruptcies will rise markedly when loan payment and rent deferral plans end, and bank earnings will fall sharply as a consequence. We expect a better sense of the severity of potential losses will come following the cessation of the deferral plans. As well, the pandemic led to a surge in purchases of bond funds that is now subsiding. Weaker demand for corporate bonds may also lead to widening yield spreads. We prefer to be conservative in selecting corporate issues, focussing on higher quality issues and reducing overall exposure to BBB-rated bonds. In the short run, we may give up some yield by focussing on higher-rated issues, but elevated risk levels make that the appropriate strategy.

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