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The Fed explicitly placed a potential rate hike at its December policy meeting on the table but indicated its decision will be data dependent. In addition to labor market data, the Fed will be looking for evidence that inflation, which remains stubbornly low, has firmed closer to its target of 2% ahead of its policy meetings on December 15–16.

The Bank of Canada chose to hold its benchmark interest rate unchanged at 0.5% in October. Recent economic data has been uneven, suggesting that the benefit of two interest rate cuts earlier in the year continues to work through the economy. The preferred share market still appears attractive for long-term investors after capitulation selling sent the market to an all-time low on October 14. While a recent 10% bounce from these lows is likely to suffer a pullback of some magnitude given the rapidity of the move, valuations remain compelling.

European Central Bank (ECB) President Mario Draghi indicated in October that additional monetary stimulus could be forthcoming at the ECB’s December policy meeting. Draghi’s hint of further stimulus fuelled a rally in corporate bonds that is likely to continue should economic data confirm further policy support is warranted.

Central bank rate (%)

*1-yr base lending rate for working capital, PBoC
Source - RBC Investment Strategy Committee, RBC Capital Markets, Global Portfolio Advisory Committee (GPAC), Consensus Economics

Sovereign yield curves

Source - Bloomberg

Regional highlights

United States
  • The Fed managed to get the markets back onside at the October FOMC meeting by stating explicitly that it is now assessing incoming economic data in order to make a decision on a potential rate hike “at its next meeting”—to take place in December. Despite the explicit guidance, the market is still only pricing 50/50 odds, with the burden back on better data to get the market closer to 100% by then. We think the bar for the Fed will simply be some stability in labor markets after the recent soft patch without a tightening of broad financial conditions that caused the pause in September.
  • Investment-grade corporate bond spreads ended October tighter for just the second time this year as attractive valuations, modest stabilization in oil prices, and a decline in broader market volatility eased investor concerns.
  • Corporate bonds have underperformed Treasuries for the last two quarters, but we see scope for a return to outperformance as 2015 comes to a close with the Fed’s stamp of approval on the economy likely to be favorable for credit markets.
10-year rate (%)

*Eurozone utilizes German bunds.
Source - RBC Investment Strategy Committee, RBC Capital Markets, GPAC

Canada
  • On October 21, the Bank of Canada (BoC) held the overnight target rate at 0.50%. The BoC is expected to take its time adjusting policy as inflation, economic growth, and employment are improving, but at a slower pace than the BoC would like. Investors can use this to add duration with 5–8 year maturity bonds as interest rates are expected to remain lower for longer.
  • The Canadian preferred share market rallied roughly 10% after hitting its all-time low on October 14. Much of this move has been driven by technical factors such as inflows into ETFs and index rebalancing. An improvement in investors’ reaction to new issuance will likely be required for this rally to remain intact. Recently, new issues have not been well received by the market and have driven the prices of existing issues lower.
Continental Europe & U.K.
  • Without formally announcing an increase in its quantitative easing program last month, the ECB continues to provide dovish rhetoric and effectively left the door open for such an increase as well as potentially moving the deposit rate further into negative territory by year-end. We think expectations for further ECB intervention should be the catalyst to keep a lid on German yields and periphery spreads at or around the levels reached last month.
  • We believe the Gilt market is likely to continue trading in line with U.S. Treasuries. Domestic data continues to improve, but with U.K. inflation well below target, we do not believe the Bank of England will look to hike rates anytime soon.
  • Increased risk appetite has driven corporate bond spreads tighter on relatively little issuer news. The recent volatility of spreads is a concern, but we view market-wide moves as opportunities for those issuers in which fundamentals remain strong. Coming out of earnings season, we expect issuance to pick up, which could limit further tightening of spreads into year-end.
Dissipating volatility drives U.S. corporate spreads tighter

Source - RBC Wealth Management, Bloomberg, Barclays

U.S. corporate spreads have tightened to the lowest levels since August as market volatility has moderated.


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