Time for large rate cuts may be over

While big rate cuts from central banks have supported bond markets over the past few years, their impact is starting to fade, says Aaron Young, vice-president of global fixed income at CIBC Asset Management.

In discussing what’s next for bonds on the Advisor To Go podcast, Young said central banks may still lower rates but the larger moves are nearing the tail end.

“The dominant theme has been lower central bank rate policies acting as a tailwind for fixed-income returns across the board,” he said. “We think part of that has played out.”

Listen to the full podcast on Advisor To Go, powered by CIBC Asset Management.

Looking ahead, Young said investors should focus on balancing steady income with stable yields in what he described as a more settled market.

One area he highlighted is the shape of the yield curve, which he described as a key factor for bond investors this year. 

“We’re back in a bit of a normalized environment where the curve is upward sloping,” he said, adding that the major changes in shorter-term rates, driven by central bank cuts, are largely priced in. Investors should consider opportunities in steepening yield curves, particularly in Canada and the U.S., he said.

“There’s still pockets of yield curves… where we can position for curve steepening,” he said. “And we think that’s a good trade.”

He pointed to differences in monetary policy and economic conditions between Canada and the U.S. as a source of investment opportunities, especially in longer-term U.S. Treasuries. 

These instruments, he said, offer an additional yield pickup and the potential for price gains compared to Canadian bonds, particularly at the long end of the curve. 

“[It’s] hard to see how it could get even richer from there,” he said of Canadian yields.

For those seeking yield, Young said safer segments of the fixed-income market, such as government bonds, provincial bonds and U.S. agency mortgage-backed securities (MBS), remain attractive. 

He described MBS as a place where investors can find “additional yield — which we like – but without taking incremental amounts of credit risk.” 

These securities, he said, are backed by the U.S. government and provide “a yield pickup above plain U.S. Treasury that’s still attractive, highly liquid.”

However, he warned against chasing higher returns by taking on excessive credit risk. Tight spreads in investment-grade and high-yield bonds mean there’s limited reward for the added risk. 

“Do we think now is the time to go all-in on credit risk, to get a few extra basis points in yield? Probably not,” he said. “There’ll be better entry points in the future.” 

Heading into 2025, Young outlined three key strategies for investors. 

First, he encouraged them to let go of recency bias from the sharp rate hikes of 2022.

“Duration is no longer the enemy,” he said, suggesting that investors consider longer maturities to lock in yields for a longer period.

Second, he emphasized the importance of quality income.

“There’s lots of yield out there, given where interest rates have gone from that zero bound. You really don’t need to put your neck out, in terms of credit risk or overall risk, to capture those yields,” he said.

Third, he recommended leveraging active management to capitalize on inefficiencies in the bond market.

“Volatility in fixed income really lends itself to active management,” he said.

This article is part of the Advisor To Go program, sponsored by CIBC Asset Management. The article was written without input from the sponsor.