Avery Shenfeld, Chief Economist, CIBC World Markets
"Financial markets are essentially assuming right now that both the Federal Reserve in the U.S. and the Bank of Canada are completely done with interest rate hikes. We still see some chance that both central banks will hike rates another quarter point before the year is out. If we see, for example, a pickup in growth towards the middle of the year. Rightly or wrongly those central banks might read that, or misread that, as a sign that the sluggish period we've been in now is behind us. We think that by 2020 if the Federal Reserve does raise rates they might have to cut them again. And we think that if there is one more rate hike by the Bank of Canada this year that's probably it. But as long as both central banks still think that there's room to raise rates I think there is a risk that they'll misread a good quarter or two as a sign that they need to take rates higher.”
Meaning of flatter yield curve?
“Investors often interpret a very flat yield curve as a signal of a recession to come. And indeed historically, if two year rates are actually above 10 year rates, it has been a good predictor of a recession within the following year or two. I don't think that it's as dire as that today, in part because 10 year rates are now unusually low and I think that's on a permanent basis. Investors no longer fear that inflation could pop back up again, so they simply don't demand the same premium to lock in money for 10 years that they used to. So you really can't compare this year's slope from two year to 10 year rates the same way as you did say, in the 70s or 80s or even in the early 90s when the memories of higher inflation were still fresh on investors’ minds.”
Impact of lower rates on investors
“A consequence of that very flat yield curve and relatively low rates is that it is hard for investors to earn a lot of money on fixed income assets, and some have been tempted in the last few years - and it's paid off over some of that period - to look at weaker credits, particularly in the high-yield bond market. I think we're getting to the point in the business cycle, however, where you have to be a little careful in that regard. We're seeing slower economic growth globally. It doesn't necessarily mean a wave of bankruptcies but it could mean some greater concern in the financial market about that eventuality, and therefore a bit of an underperformance for those weaker credits. So it's a time still to hold corporate bonds, but perhaps think about upgrading the credit quality of those corporate bonds, even though you sacrifice yield in the process.”