Fixed income update

How 2023 closed and what does 2024 look like

Head Fixed Income Trader Harvey Libby returns to the podcast to discuss fixed income, including:

1. The environment at end of 2023
2. Inflation
3. Rates
4. Opportunities in 2024

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Transcript

Chris Cooksey: Hello, and welcome to the Advantaged Investor, a Raymond James Limited podcast, a podcast that provides perspective for Canadian investors who want to remain knowledgeable, informed, and focused on long term success. We are recording this on January 9, 2024. I'm Chris Cooksey from the Raymond James Corporate Communication and Marketing Department, and today, head fixed income trader, Harvey Libby returns to the podcast. Harvey is a regular contributor to the podcast and today he and I will recap the end of 2023, discuss inflation and rates, and take a look at the opportunities as we begin 2024. Welcome back to The Advantaged Investor, Harvey. You are the first guest in 2024. Thanks for taking the time to help with episode number 86. I hope you are doing great.

Harvey Libby: Thanks, Chris. Yeah, I'm doing well. I hope you're doing well as well.

Chris Cooksey: Thank you very much. I am doing fantastic. As always, when we have our discussions, there's lots to get into, so let's jump right in and let's just start with how we ended 2023 where markets were at] and positioning towards 2024.

Harvey Libby: Sure, that sounds great. Basically at the end of 2023, the last quarter anyways, fixed income markets were on a big time roll, and then yields came down dramatically, like historic dramatic movements in yields. Just to give you an idea, five-year Canada's dropped 125 basis points in yield from the beginning of October to the end of the year. For 10-years, we're down about 110 basis points in yield and long bonds were down about 100 basis points in yield. Just to give you an idea, price wise on a long-term 30-year Canadas dropping 100 basis points in yield. That was like $14 in price difference. So it went up in price by $14 the last two months of the year.

So we had a big reversal from the first half of the year. That's for sure. And I know you want to touch base a little bit on inflation as well. Just to give you an idea on what happened with inflation during the year, we all know inflation was, you know, extremely high the first half of the year. We basically measure inflation by the CPI numbers. So CPI in January 2023 was at 5. 9 percent, by November, which is our last reading that we have right now, it's down to 3.1%. So we're getting closer to our target or the government target rates of the 2 percent to two and a half kind of target. Inflation seems to be coming back in line. Personally, I think it'll stay up a little bit higher than the government wants it to get down to, but you know, it'll work itself out probably by the end of next year, I would expect - sorry, the end of this year.

Chris Cooksey: So, like, historically, though, we know that inflation or rates tend to be either longer or, higher or lower longer than what's generally expected. And that's sort of what you're saying here is while the government thinks it might happen sooner, you would expect by the end of the year type situation.

Harvey Libby: Yeah, there seems to be an overhang all the time, right? The thing that bothers me was how the fixed income market dropped in yield so suddenly, because nothing goes one way in a direct line ever. And being a trader, and I'm more a trader than anything else, I'd say I usually see a little bit of a pullback and you have seen a pullback from December 31 levels. So 5-year Canadas have, sorry, gone up in yield by about 16 basis points. 10-year Canadas between 10 and 20 basis points for all areas on the curve since December 31. So, I think that's just giving back a little bit of the exuberant rally that we had going into the market or going into the equities and fixed income markets at the end of the year. I think everyone was just trying to jump on board. Personally, I feel that it was kind of, and I was telling people this, like the last week of December, it seemed to be like a Goldilocks scenario, people were saying, in the States especially, five or six cuts for the Fed coming into 2024, they're going to start like in February. It seemed to be too rosy of a picture that everyone was putting on the whole market and we seem to rally dramatically because of that. So I did expect a little bit of a pullback. I'm not sure how much more we're going to get, but we have got between 10 and 20 basis points here in the first week of January, which is good. It's a good time to start thinking about using your dollars and getting back into the market, I believe, now.

Chris Cooksey: So safe to say, basically, it's a battle between opinion right now. How quickly will inflation subside and when rates start going down? Correct? I think everyone agrees rates are going lower. How long is it going to take?

Harvey Libby: Okay, right and I think a lot of people are saying we're going to be higher for longer. So you got two camps It's higher for longer, but rates are still going to get lower Okay, or right, we're going to get lower quickly so either way in my mind you have to keep getting invested because rates are going the same way. They're going lower eventually, right? So you might as well take advantage of these rates. If you don't get the top of the rates, if you don't get the best yields you're still going to be invested for longer. So you should be invested and that's basically the whole thing.

Chris Cooksey: Okay, so it's a timing issue, we're going to talk about rates now anyway. The consensus is rates will go lower. Obviously, stuff can happen out there that would cause opinions to change. But as we sit now, the expectation is rates will move lower. It's just whether that starts next meeting or mid year or towards the end of the year.

Harvey Libby: Correct. So like economists right now are thinking by the end of June that Canada's will be slightly lower. In the U.S. will be 10 to 25 basis points lower in yields. So they're going to do a little bit better for their fixed income markets from now until June. But Canada will be, like the short-term rates are probably get a drop, economists are thinking about 25 basis points where the long end is basically going to be flat. So you got to take a look at the yield curve as well and see where you should be positioned on the yield curve for where the economists think that rates are going.

Chris Cooksey: And as we've discussed in previous episodes, Harvey, like one of the great ways to help with that, is a laddered approach where you're just putting money in constantly to sort of smooth that potential risk out.

Harvey Libby: That's exactly the safest, most conservative way to be in the market. And it makes the most sense. Cause yeah, every year in a normal yield curve environment, rates are higher in the long-term. So when something comes due in the short term, you're reinvesting it. to the better rates. Right now, that's not the case because our yield curve is still inverted, but eventually that has to come back and go back to a normal sloping curve where yields are higher at the long end. And that's what we're waiting for, what I'm waiting for right now. And it's kind of hard to tell where you should be on the curve to not get hurt. If that does happen, and I think even just looking at economists view where they think rates are going, you want to be in the 8 to 10 year area is probably a safe place to be or 7 to 8 somewhere in there.

Chris Cooksey: Okay, and let's just finish off with maybe some of the opportunities or the opportunities you expect as move throughout 2024.

Harvey Libby: Well, I think right now by the end of December, after tax, corporate issues weren't looking as attractive as they had for the last six months. They were the biggest opportunity in 2023, in my opinion, the after-tax opportunities in the market were vast, lots of great opportunities. You could get a, a yield of 5 percent and an after-tax yield of 3%, where you're looking at a 50 25 percent tax bracket. So that equates to a regular 6%. If you were buying a GIC at 6%, that would equate to the after-tax yields of these corporate bonds. Cause of the fact, you would buy them at a discount to a hundred, they would mature at a hundred and the capital gain is taxed differently than the than the interest income. So if it's in a taxable account, it makes sense. To buy the after-tax product right now, it's come back a little bit in the last couple of weeks with adding 20 basis points to yields. We are back in the position, I was just taking a look at after tax yields right now and your best thing to compare, I guess, is GICs versus after-tax yields. So for the average investor, everyone knows what a GIC is, you can buy yourself a big bank corporate bond that's at a tremendous discount to a hundred or at a big discount to a hundred and get the after-tax, which is a better after-tax yield than buying a GIC.

So, right now it does make sense. So GICs right now in Canada, one to five years, it slopes downward, so it's like over 5% for a one year, where it's only 4.4% for a five year. Okay. And after tax wise, if you buy a one to five year corporate bonded discount, after tax wise, it will yield more. You should take a look at that, and you should talk to your financial advisor about the opportunities, especially if you're in the top tax bracket and you want the capital gain for the tax benefits.

Chris Cooksey: All righty, well, let's leave it there. I appreciate your time today, Harvey. Always a pleasure speaking with you, and I look forward to your next visit and update in a, in a in a few months.

Harvey Libby: Sounds good. Chris,

Chris Cooksey: Reach out to us at AdvantagedInvestorPod@RaymondJames.ca. Subscribe to The Advantaged Investor on Apple, Spotify, or wherever you get your podcasts. Please contact your advisor with any questions you have. On behalf of Raymond James and The Advantage Investor, thank you for taking the time to listen today. Until next time, stay well.

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