Market outlook: First quarter 2024

01 February 2024 by National Bank Investments

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The fourth quarter started on a continuing theme of higher-for-longer interest rates and a general reduced appetite for risk, but by Mid-October there was a material reversal on both fronts. Fiera Capital Corporation, portfolio sub-advisor to the NBI Corporate Bond Private Portfolio (the “Fund), provides an overview of the last quarter and shares what opportunities lie ahead.

Read the portfolio sub-advisor’s comments for this Fund included in certain NBI Private Wealth Management profiles.

North American bond yields were much lower across the yield curve over the last three months. The change occurred after several central bank meetings (Federal Reserve (Fed), Bank of Canada, and European Central Bank (ECB)) and the release of economic data. The combination of monetary authorities hinting that rate hikes were ending along with softer inflation and employment data, caused markets to pivot towards rate cuts. Central banks attempted to push back on rate cuts, but this did not stop the market from pricing in multiple interest rate cuts starting in early 2024.

Interest rates finished the quarter significantly lower across both U.S. and Canadian bond markets with 10-year rates falling 100 and 90 basis points (bps)¹, respectively. European 10-year rates were also lower by 70 bps. This environment also triggered a strong rally in equity and credit markets. Mid-term corporate bond spreads narrowed 17 bps to 161 basis points.² Canadian Corporate Bonds, as measured by the FTSE Canadian Corporate and government benchmarks outperformed cash returns during the quarter.

Outlook and Challenges

Global growth was stronger than expected in 2023 and unemployment rates remained low even as financial conditions tightened materially. With central banks now potentially pausing rate hikes, we expect the outlook for growth in major economies to be soft in 2024. The U.S. economy should operate below potential, but we expect the Canadian economy to enter a shallow recession.

Inflation has declined from very elevated levels over the past year and if it continues to fall it will give the Bank of Canada confidence, they will hit their two percent inflation target and allow them to begin the process of loosening monetary policy. We expect several rates cuts in both Canada and the U.S. in 2024 which will provide some support in avoiding a hard landing in the economy.

During 2024, we expect Canadian interest rates and credit spreads to stay low, supporting positive fixed income returns. However, we expect some volatility in rates and spreads as central banks transition to interest rate cuts, elevated bond supply and geopolitical risks. The near-term outlook for rates and credit spreads will be impacted by the timing of the first-rate cut by the Fed and the Bank of Canada. While current data shows improvements on the inflation front, more work still needs to be done to support central banks in cutting rates. Core measures of inflation will also need to trend lower during the year. We expect the Bank of Canada and the Fed to cut interest rates in the range of 75 to 125bps for the year.

Fund Strategy

Portfolio duration was slightly above the benchmark to begin the quarter as we had taken advantage of the back-up in rates in September and to reflect our forecast of softer economic growth. We increased the term to maturity of the portfolio until mid-October, when we paused as rates began to decline. Over the balance of the quarter, we sold bonds as rates moved towards our base case of softer growth. The portfolio ended the quarter slightly short of the benchmark.

For next year, using our base case of 75 to 125bps of interest rate cuts from the Bank of Canada, we expect there will be many opportunities like in 2023 to adjust our duration strategy. The Fund benefited from the carry, sector allocation, and security selection. We have recently taken profits on certain names that have gotten expensive in our view, and we will continue to remain cautious.

As investment grade credit spreads remain wide in the historic context, despite some spread compression in November and December, we feel that certain segments of credit markets compensate well for these uncertainties, especially short corporate bonds with solid fundamentals (by performing an analysis of fundamental criteria, it is possible to make a selection of assets likely to be valued over the long term). We consider our current credit risk exposure as moderate and having a bias towards quality issuers and sectors well-positioned to face a shallow recession. If corporate spreads tighten more, we could look to take further profits, or if they widen to reflect a significant slowdown, we could increase our credit risk exposure. We continue to closely monitor issuers that are more sensitive to higher interest rates. The yield carry from our credit positions has increased slightly since the end of September to 27 bps.

¹One (1) basis point (bps) is equal to 0.01%
²As at December 18, 2023

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The information and the data supplied in the present document, including those supplied by third parties, are considered accurate at the time of their printing and were obtained from sources which we considered reliable. We reserve the right to modify them without advance notice. This information and data are supplied as informative content only. No representation or guarantee, explicit or implicit, is made as for the exactness, the quality and the complete character of this information and these data. The opinions expressed are not to be construed as solicitation or offer to buy or sell shares mentioned herein and should not be considered as recommendations.

The views expressed regarding a company, a security, an industry, a market sector in particular, future events (such as market and economic conditions), a company's or a security's performance, upcoming product offerings or other forecasts are solely those of Fiera Capital Corporation and do not necessarily represent the views of National Bank of Canada and its subsidiaries (the “Bank”). These views are subject to change at any time based on market or other conditions and could cause actual results to differ materially from the ones anticipated by Fiera Capital Corporation. The Bank disclaims any responsibility to update such views. They do not constitute recommendations to buy or sell nor investment advice.

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