Thanks to lower inflation and monetary easing, a majority of G7 government bonds rallied in the third quarter of 2024, with Canadian bonds leading the pack. That’s according to Sandrine Soubeyran, FTSE Russell’s director of global investment research.
“Most G7 government bonds have rallied in Q3, and we can see that the shorter maturities modestly outperformed as they benefited from that low inflation,” Soubeyran said in the firm’s fixed-income webinar Wednesday.
In the past month, bond yields rose significantly following the U.K. government’s first budget and the U.S. election. Soubeyran said investors expect higher rates “to persist for longer as a result of these events.”
Canadian government bond returns “fared relatively well” during this period, posting flat or modest, positive returns, versus mostly negative returns elsewhere in the G7, she said.
For the year to Oct. 31, short-duration bonds benefited from central bank easing and low inflation, while bonds with longer durations saw negative returns. In Canada, for example, short-, medium- and long-duration bonds posted returns of 3.8%, 2.3%, and –2.1%, respectively.
“It’s the battle between shorts and longs,” Soubeyran said.
She noted that Canadian government bond returns in local currencies “look better than other G7 peers” year to date, highlighting the “huge currency impact” on returns for Canadian investors.
High-yield credit dominated performance in the third quarter and year to date.
In Q3, Canadian high-yield corporate bonds posted returns of 3.5%, while U.S. high-yield bonds saw 3.7% returns. By comparison, both Canadian and U.S. investment-grade bonds posted returns of 2.2% during the three-month period.
For the year to Oct. 31, Canadian high-yield corporate bonds posted returns of 9.5%, while U.S. high-yield debt saw 13.8% returns. Canadian investment-grade bonds posted year-to-date returns of 5.4%, while U.S. investment-grade bonds had returns of 8.8%.
Soubeyran noted that Canadian and U.S. investment-grade bond spreads were “highly correlated during [Covid-19] and the [monetary] tightening phase,” but that has changed.
“Since 2022, Canadian spreads have decoupled and widened, in line with the U.S. growth desynchronizing and the easing and lower inflation expectations … which resulted in Canadian corporate spreads widening versus the U.S. investment-grade spreads,” she added.
The reverse is true for Canadian and U.S. high-yield corporate bonds, which have “reconverged after decoupling” in the earlier days of the pandemic,” Soubeyran said.
In the investment-grade universe, A-rated Canadian bonds have increased in weight since 2019, mirroring the decrease in weight of AA-rated investment-grade bonds. The weight of BBB-rated bonds also decreased during that period.
When it comes to provincial bonds, Alberta has decoupled its spreads from other provinces with AA credit quality ratings, Soubeyran said. This is due to the debt-to-GDP ratio estimate for Alberta being “very small and expected to go smaller, compared to much more significant and high ratios from the other provinces, especially in Ontario and Quebec,” she noted.