North American central banks, the Bank of Canada and the U.S. Federal Reserve have laid out their intentions for the next 24 months. They have explicitly indicated that they intend to leave their overnight interest rates at their current levels, 0.25%, until 2023. These communications are intended to provide capital markets with the certainty that low interest rates will continue to support the economic recovery. Taking it a step further, both central banks are in the process of purchasing securities in the open market, namely government and corporate bonds. This action will also serve as a line of support for both the economy and markets. Lastly, the U.S. Federal Reserve has indicated that they will be targeting long-term average inflation going forward, as opposed to simply targeting 2% inflation at a point in time. What does this all mean for the bond market? The implications are three-fold. First and foremost, one should anticipate short-term interest rates to remain low through 2021.
Secondly, although corporate bond spreads have recovered significantly, they should remain relatively stable given that central banks are directly supporting them through their purchase of corporate bonds in the open market. Third, with central banks now focusing on long-term average inflation, longer-term interest rates are likely to drift higher even though short-term interest rates may remain stable; this trend has begun to unfold. Overall, this lends to a stable but modest return outlook for the fixed income market in Canada. Within our Matco Fixed Income Fund, we continue to adjust our portfolio positioning to maintain a healthy level of income while avoiding unnecessary risk.