Steve Locke, PM, MacKenzie Sentinel Bond Fund discusses his outlook for interest rates.
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Steve Locke - Outlook for Interest Rates
Steve Locke, 16 year veteran, bond trader, credit analyst, and currently, bond manager of Mackenzie Sentinel Bond Fund, discusses his interest rate outlook with Dan Richards.
DR: Steve, you're co-head of the bond team for Mackenzie's Sentinel Group of Funds, and we're going to talk today about your outlook for interest rates. Why don't you start by talking about where interest rates are today, short term and long term.
Steve Locke: Well, short term rates today are very low, as are long term rates, compared to their history. Short term rates today at the beginning of September, the overnight rate was just set by the Bank of Canada at 1%; for longer term, the 30-year part of the Canada Government yield curve, currently those rates are just a little over 3.5%.
DR: So 1% short-term, 3.5% long-term. How does that compare to historical norms?
SL: Historically, rates have been higher than this. Currently, we're at a very very low setting across the yield curve, and particularly, on the shortest term part of the yield curve, where the policy rate reductions that have taken us through the last recession and into the recovery have pushed short term bond yields quite a bit lower. They are currently about 3.5% below where they were 4-5 years ago, but in the longer part of the yield curve, yields are not as much lower; there, we're only about 100 bps below the historical average.
DR: Steve, sometimes people will pick up the paper and they'll read about the bond market pricing in an increase or a decrease for interest rates. Can you talk about what that means, exactly.
SL: Sure, what we're talking about there is the slope of the yield curve, which over time is typically upward sloping, where short term yields are below long term yields. What we can infer from that curve is that there is an expectation built into it over time that rates will rise, yields will rise. In particular, when we look at the T-Bill curve, the Government of Canada T-Bills, that implies what the Bank of Canada might be doing with its policy rates, over the next few sessions.
DR: So by 'policy' rates, what do we mean exactly?
SL: What we mean is the 'Overnight' rate, which is the policy setting tool for monetary policy. Its the rate that really governs the shortest term lending in Canada, particularly between financial institutions.
DR: Now you mentioned that there is normally a positive slope where short term rates are lower than long term rates. What does the slope today look like, compared to what it would look like historically?
SL: The slope is actually quite steep, that is, short term rates are well below longer term rates. In fact if you look at the two year yield in Canada, currently about 1.5% compared to the 30-year yield of 3.5%; that implies a two hundred basis points, or 2%, slope to the curve. However, over the course of history, we've seen the average of that curve a lower than that, around a 100 basis point or 1% slope between the 2-year and 30-year bond yields.
DR: So a steeper yield curve in general would imply the bond market expects an increase in interest rates, if I understand you correctly, and what's your view on that? Do you think that's going to materialize?
SL: I think for the nearer term, certainly the bank has indicated that it would like to raise the policy overnight rate, however over the medium term, I think we need to realize that expectations of rate increases taking us well out into the future are a little bit perhaps overdone on the slope of the curve today.
What I mean by that is that over time we need to see some other developments in the economy and on the inflationary side, really come back through the recovery, for us to meaningfully push yields higher from here.
DR: Steve, Thank you.
Source: ClientInsights.ca
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