The U.S. Federal Reserve (Fed) and the Bank of Canada (BoC) will be kicking off their tightening cycles next month. This tightening means they will begin increasing their overnight interest rates, which puts upward pressure on longer-term interest rates. The full outlook is for the Fed to increase their overnight rate in the next two consecutive meetings through June. The BoC is also set to hike rates in their subsequent two sessions through July. Beyond mid-year, both central banks are expected to increase their respective overnight rates at a quarterly cadence. The greater sense of tightening urgency has been prodded by inflation.
In December, the Canadian Consumer Price Index (CPI) increased 4.8% year-over-year, a 30-year high and running at a 4.8% annualized rate in the latest three months. The U.S. CPI rose 7% year-over-year, a 40-year high and running at a 9.1% annualized rate in the past three months. This momentum, along with oil’s multi-year-high and Omicron’s worsening of labour and product shortages, suggests even higher inflation readings during the months ahead. North of the border, a lacklustre loonie is compounding the impact of oil prices and resulting in record-high gasoline prices. Business restrictions are countering Omicron’s inflationary impulse by dampening demand, but these restrictions are already being lifted. On both sides of the border, while inflation should begin to move lower as we approach the third and fourth quarter of this year, the risks of persistently elevated inflation are compelling central banks to act more aggressively.
Within our Matco Fixed Income portfolio, we have been preparing for these market developments since mid-2021. We have reduced our bond portfolio term by approximately 2 years. Our reduction means that the bonds held within our Fixed Income portfolio will be less susceptible to the negative impact of rising interest rates. We complemented this adjustment by adding a 14% position in rate-reset preferred shares. These securities perform well in a rising interest rate environment, paying a healthy stream of income while their prices often rise at a steady pace. We also hold an 18% position in floating-rate notes. These securities are fully hedged from the impact of rising interest rates. In fact, they benefit as their income level will continue to adjust higher as overnight interest rates rise.
These portfolio management adjustments are examples of how active investment management can help your portfolio navigate an evolving investment landscape. Our Matco Fixed Income Fund process keenly focuses on preserving our investors’ capital while ensuring a healthy stream of income flows to our unitholders. Just like teeing it up on the golf course, it’s crucial to understand how the course is laid out in front of you. Some holes call for a conservative approach, where hitting the fairway will give you the best chance at making birdie. Other holes are wide open and attacking with your driver is the best course of action.
The Bottom Line
The course for 2022 is littered with bunkers and water hazards of higher interest rates. Our portfolio adjustments are designed to help keep us in the fairway. If you would like to discuss how our portfolio positioning could help you navigate the year ahead, please don’t hesitate to reach out.
Trevor Galon, CFA
Chief Investment Officer
Founded in 2006 to manage and service seven family offices, today Matco offers the benefits of our extensive investment management experience to individual investors, foundations, endowments, condominium corporations, trusts, corporations and not-for-profit organizations.
Our mission is to simplify the investment world for our clients by understanding their needs and providing exceptional investment solutions that preserve and grow capital.