BMO Canadian ETF Dashboard

— as of July 31, 2019 —

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Navigate the Late Cycle with Low-Cost Fixed Income

Alfred Lee

Navigate the Late Cycle with Low-Cost Fixed Income

Snapshot
Following the Federal Reserve’s recent interest rate cut, investors should remain cautious on the fixed income side of their portfolios. A focus on lower fees can help protect your clients’ returns in this environment, especially if bond yields continue to remain low. To this end, ZCB and ZGB provide:

  • Low-cost exposure to Canadian fixed income. At 15 basis points each, ZCB and ZGB offer access to corporate and government debt with an eye to fee reduction and diversification.
  • Risk mitigation for later stages of the business cycle. ZCB and ZGB are broadly diversified across the entire yield curve to account for unpredictable shifts in monetary policy.  

Details
BMO Corporate Bond Index ETF (Ticker: ZCB)
BMO Government Bond Index ETF (Ticker: ZGB)

Benefits
Cost efficiency. Risk mitigation. Diversified fixed income exposure.

Trade Idea – ZCB and ZGB
At a recent meeting of the Federal Open Market Committee (FOMC), Fed officials decided to lower the overnight interest rate by 25 basis points in light of “the implications of global developments for the economic outlook.”1 The target range for the federal funds rate is now 2% to 2.25%. And with the market expecting bond yields to remain low over the near term, there is a strong temptation to enter high yield assets. However, our preference is to err on the side of caution.

Despite strong labour market conditions, there is compelling data suggesting the U.S. economy has peaked. Factory and durable goods orders have decelerated; Institute for Supply Management (ISM) manufacturing recently trended downwards; and we have seen inversions at the front end of the yield curve, indicating the start of a down cycle sometime in the next 12 to 16 months. As a result, investors may need to start de-risking their portfolios, by rotating funds from aggressive growth areas to the relative safety of Canadian investment-grade and government bonds.

Fixed income investors should also focus on the entire term rather than specific parts of the curve, in order to accommodate multiple possible interest rate scenarios. Within the space our preference is ZCB, given that it falls in the “goldilocks” zone, offering more yield than ZGB and more safety than junk bonds. To be clear, though we continue to believe that high yield bonds and emerging market debt play an important role in asset allocation, as tactical investors we recognize the need to mitigate the uncertainty of transitioning to later stages of the business cycle.  

bmo-etfs_01chart1_848px_2019-08-06_ENG.jpg#asset:3062

Outlook
Due to the new dovish stance from the Fed, the market is now pricing in a total of three rate cuts in this calendar year. However, given that there are only four FOMC meetings left in 2019, we find the possibility of three cuts by year-end to be overly aggressive. If the Fed takes emerges more hawkish than expected, as is our belief, risk assets could retreat and interest rates could reprice higher. Meanwhile, the Bank of Canada (BoC) has taken more of a wait-and-see approach. Although it may be compelled to follow suit if the interest rate differential drives the Canadian dollar too far up against the greenback, the BoC remains wary of increasing the nation’s household debt.

 


1 https://www.federalreserve.gov/monetarypolicy/files/monetary20190731a1.pdf

Alfred Lee

Navigate the Late Cycle with Low-Cost Fixed Income

Snapshot
Following the Federal Reserve’s recent interest rate cut, investors should remain cautious on the fixed income side of their portfolios. A focus on lower fees can help protect your clients’ returns in this environment, especially if bond yields continue to remain low. To this end, ZCB and ZGB provide:

  • Low-cost exposure to Canadian fixed income. At 15 basis points each, ZCB and ZGB offer access to corporate and government debt with an eye to fee reduction and diversification.
  • Risk mitigation for later stages of the business cycle. ZCB and ZGB are broadly diversified across the entire yield curve to account for unpredictable shifts in monetary policy.  

Details
BMO Corporate Bond Index ETF (Ticker: ZCB)
BMO Government Bond Index ETF (Ticker: ZGB)

Benefits
Cost efficiency. Risk mitigation. Diversified fixed income exposure.

Trade Idea – ZCB and ZGB
At a recent meeting of the Federal Open Market Committee (FOMC), Fed officials decided to lower the overnight interest rate by 25 basis points in light of “the implications of global developments for the economic outlook.”1 The target range for the federal funds rate is now 2% to 2.25%. And with the market expecting bond yields to remain low over the near term, there is a strong temptation to enter high yield assets. However, our preference is to err on the side of caution.

Despite strong labour market conditions, there is compelling data suggesting the U.S. economy has peaked. Factory and durable goods orders have decelerated; Institute for Supply Management (ISM) manufacturing recently trended downwards; and we have seen inversions at the front end of the yield curve, indicating the start of a down cycle sometime in the next 12 to 16 months. As a result, investors may need to start de-risking their portfolios, by rotating funds from aggressive growth areas to the relative safety of Canadian investment-grade and government bonds.

Fixed income investors should also focus on the entire term rather than specific parts of the curve, in order to accommodate multiple possible interest rate scenarios. Within the space our preference is ZCB, given that it falls in the “goldilocks” zone, offering more yield than ZGB and more safety than junk bonds. To be clear, though we continue to believe that high yield bonds and emerging market debt play an important role in asset allocation, as tactical investors we recognize the need to mitigate the uncertainty of transitioning to later stages of the business cycle.  

bmo-etfs_01chart1_848px_2019-08-06_ENG.jpg#asset:3062

Outlook
Due to the new dovish stance from the Fed, the market is now pricing in a total of three rate cuts in this calendar year. However, given that there are only four FOMC meetings left in 2019, we find the possibility of three cuts by year-end to be overly aggressive. If the Fed takes emerges more hawkish than expected, as is our belief, risk assets could retreat and interest rates could reprice higher. Meanwhile, the Bank of Canada (BoC) has taken more of a wait-and-see approach. Although it may be compelled to follow suit if the interest rate differential drives the Canadian dollar too far up against the greenback, the BoC remains wary of increasing the nation’s household debt.

 


1 https://www.federalreserve.gov/monetarypolicy/files/monetary20190731a1.pdf