Market review
The Bank of Canada (BoC) cut rates twice by 25 basis points (bps) in the third quarter of 2024 (Q3), moving the overnight rate from 4.75% to 4.25% to spur activity in the Canadian economy as Canadian inflation continued to fall. With Canadian core and headline inflation now approaching 2% and the BoC moving to support lackluster Canadian economic growth, the Government of Canada yield curve rallied and steepened. Canada one-year bonds led the way, falling 90 bps in Q3. With Canada’s federal government less willing to make broad changes through either tax reform or investment incentives, the market has priced in additional rate cuts by the BoC well into 2025.
With additional demand for bonds in Q3, corporate bond issuers stepped up supply. With over $27 billion of new corporate bond issuance in Canada in Q3, it was the busiest third quarter for issuance since 2019. New issuance concessions were often close to zero or even negative as demand for bonds outstripped supply and new issues often repriced issuers' credit curves. New corporate bond supply was more concentrated toward the middle of the term structure, with the 5-7 year term seeing almost half of the total supply.
Meanwhile, the shortest and longest parts of the term structure saw the lowest share of new issuance. Despite the concentration of new bond supply in the middle terms, the Canadian corporate bond credit spread curve continued to steepen this quarter. This contrasted with the U.S., where the credit curve flattened marginally. Canadian corporate credit spreads matched the U.S., as overall spreads tightened by 6 basis points (bps) in both markets, according to Bloomberg indices. The best performing sectors in the Canadian corporate broad market were real estate and financials. Provincial bond credit spreads were marginally tighter in Q3. Provincial spreads were led by the shorter-term issues.
Market outlook
Canadian GDP appears on track to deliver 1% growth this year, which is certainly below trend and potential. However, Canada’s post-pandemic bounce back has been slower than the U.S. and some other peers. This is partly because of stricter lockdowns, but goods exports to the U.S. were also slow as U.S. consumers switched to splurging on services over the last few years.
Higher rates have slowed activity and cooled the housing market in Canada. And even as the BoC cut rates, housing inventory continued to rise as prices generally remained flat. Meanwhile, employment growth has been solid even as an immigration surge bolstered labour supply and pushed the unemployment rate up.
But things are improving. The good news is inflation is returning to target quicker than expected. This leaves the BoC room to cut rates further and help the economy perk up. Canada’s GDP growth is expected to be close to 2% in 2025.
In the U.S., the Bureau of Economic Analysis (BEA) recently recalculated its growth figures for the past five years and concluded that GDP grew faster than previously reported.
The new estimates show GDP grew faster from 2021 through early 2023. The resilient labour market has been the bedrock of the U.S. recovery. And the outlook for 2024 and 2025 suggests U.S. GDP is likely to grow by over 2%.
China, the world’s second largest economy has struggled to gain momentum in its post-pandemic recovery. With China hampered by a property slump and weak consumer sentiment, investors worry that the country could miss its growth target this year. But recently, the People’s Bank of China announced policies designed to encourage economic activity and markets.
Fund review
During Q3, Sun Life Core Advantage Credit Private Pool (the “Fund”), Series F, outperformed its benchmark, the FTSE Canada Universe Bond Index.
The Fund’s credit positioning drove most of the fund outperformance. According to the Bloomberg Canada Aggregate Corporate Total Return Index, Canadian corporate spreads slightly outperformed U.S. corporate credit spreads in Q3. The Fund's cross currency hedges were a significant source of outperformance as U.S. bond swap spreads tightened 13 bps. This gave the Fund's swap hedges a large mark-to-market gain.
During Q3, the Fund’s decreased its weight to corporates in favour of federals as corporate bond credit spreads tightened. In corporates, the Fund participated in new issues from Mercedes and U.S.-dollar denominated bonds from BlackRock and took some profits in Canadian-dollar denominated bonds from Coastal Gas and TMX Group.
