Stone Investment Group Limited » Aviva Investors Canada Inc. Fixed Income Quarterly Commentary – March 31, 2017

Aviva Investors Canada Inc. Fixed Income Quarterly Commentary – March 31, 2017

Market Commentary
Commentary By:
Commentary Date: April 28, 2017
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(As of December 31, 2016)

Q1 2017 saw the global economy build on the improvement seen in H2 2016. Nearly 10 years after the onset of the global financial crisis, the scars left on the world economy may finally be fading. While progress is most clear in the United States, what has been encouraging about developments in recent months has been the synchronized and broad-based nature of the growth upswing. According to Markit PMIs, global manufacturing rose to near its strongest rate in over five years in February, with gains seen across both developed and emerging markets.

The rapid improvement in global manufacturing is in stark contrast to H1 2016, when many feared global recession. The recovery in manufacturing has also been accompanied by a pickup in global trade volumes. Trade growth has been slower than global output growth for much of the past five years, a highly unusual situation. However, the most recent indicators suggest that trade growth is likely to rise above output growth in the coming months.

While the manufacturing upturn has been particularly notable, the service sector has also seen gains, albeit they have been somewhat more muted.
The rate of improvement has also been starker in survey-based measures than it has in the official or ‘hard’ data.

Looking ahead, we will be looking to see the hard data better reflect the survey evidence. If it does, as we expect, it should translate into global GDP growth of around 3.5% in 2017, the fastest rate of growth since 2011. Across the major developed market economies we expect modestly above-trend growth for all but the UK. The rise in global growth has come at the same time as global inflation has risen to multi-year highs. Having risen modestly H1 2016, CPI inflation picked up more rapidly in the major developed economies in recent months. That pickup reflects a stabilization and subsequent increase in commodity prices during 2016. That saw the contribution to inflation from energy and food move from deeply negative to modestly positive. Core inflation, which removes energy and food price inflation, has risen moderately in the US, but has been low and stable in the euro zone and Japan. With above-trend growth expected in the major economies this year, spare capacity will continue to be eliminated, which should put upward pressure on wage growth and core inflation.

One important consequence for investors of the brighter economic outlook is the prospect of accommodative monetary policy across the world coming to an end. The Federal Reserve has already raised rates three times and we expect they will deliver two more hikes this year and a further three in 2018. More importantly, there has been growing acceptance by market participants that this is the appropriate response to economic developments. This is still an extremely slow pace of tightening by historical standards and the more plausible risk case is that more rather than less may be required, either because inflationary pressures increase more quickly or because fiscal stimulus adds to the pace of growth in the US.

Arguably the more significant change recently has been the increasing belief that other central banks – the European Central Bank and the Bank of Japan – have done as much as they can or should in terms of stimulatory monetary policy. They may now also be considering how to move away from the more radical elements of their policy stance – plotting their exit strategies from quantitative easing and negative interest rates. Neither is likely to be in any great hurry to act, but the fact is that such options are even being debated.


In the first quarter of 2017 the FTSE TMX Canada Universe Bond Index generated a return of 1.24%.1 The strength was driven by falling Government of Canada yields, running yield, and tightening credit spreads in the provincial and corporate sectors.

We remain constructive on the Canadian investment grade bond market but our view has moderated versus last year. Our positive view stems from:

  • The Canadian dollar remains significantly lower than the much stronger levels of the previous five years. This should help to offset expenditure challenges across central provinces by bolstering non-energy exports
  • Lower-than-historical issuance is expected to provide a technical tailwind to credit spreads

These factors are partially tempered by the following:

  • Credit spreads have tightened significantly since their early-2016 levels and are below historical averages
  • the stretched balance sheet of the average Canadian household
  • concerns around geopolitical events, and in particular, the impact of a protectionist Trump agenda for Canada
  • the potential for weaker-than-expected North American growth and a moderation in view of the efficacy of the Trump administration’s pro-growth agenda
    During the quarter, our trading was focused on providing liquidity for Aviva Canada and optimizing portfolio positioning. Trades included (i) selling short dated, low book yield bonds (ii) investing in bonds with more attractive risk characteristics (iii) eliminating exposure to bonds where analysts had credit concerns and (iv) purchasing new style reset preferred shares (with coupon floor).

1 Source: FTSE Russell as of March 31, 2017

Aviva Investors Canada Inc., March 31, 2017


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