In its latest bond strategy report, BMO Nesbitt Burns recommends underweighting corporate bonds, citing weak stocks and a softer global economy.

BMO says that the Bank of Canada is torn between higher-than-expected inflation and growing external risks. “The Bank may stand pat again in October given the clear slowing underway in the global economy. However, the Bank remains poised to eventually tighten further, especially with inflation now taking aim at the 4% level in the months ahead.”

Nevertheless, it concludes that the October 16 rate decision will be another close call. “Global risks and the very real chance of a November Fed rate cut suggest that the Bank will stay on hold again,” it concludes. “While the Bank of Canada is on hold for now, its fiery rhetoric suggests that short-term spreads are poised to widen further. If the Fed remains on hold, the Bank is expected to begin tightening again. If instead the Fed decides to trim rates, the Bank is highly unlikely to follow suit. Thus, in either scenario, the short-term spread is poised to widen, exerting some upward pressure on longer-term spreads.”

BMO says that provincial bond spreads have been fairly stable. “Five-year and 10-year spreads were unchanged. Thirty-years were tighter by a basis point across the credit spectrum on continued good demand from institutional accounts. We expect further spread compression on continued lack of new issue supply over the coming weeks.”

In the corporate sector, BMO says that just $1.5 billion in new issues came to market in September, short of expectations. “High-grade issuers continue to find good reception in the new issue market,” it says. “Secondary market performance during the month was mixed, as individual names moved wider while the general tone remained positive. We continue to see demand for higher rated names, and little mercy for those who falter.”