RBC InvestEase is an investment management platform that combines technology, digital accessibility and professional portfolio management and advice all for a low cost. Our portfolios are managed by professional portfolio advisors and utilize Exchange Traded Funds (ETFs) structured to help you achieve your financial objectives within your risk tolerance and time horizon. Our team of professional portfolio advisors would like to take this opportunity to comment on the recent market volatility. We would like to thank our partners at RBC Global Asset Management and RBC Wealth Management for their invaluable contributions in making this note possible.

Originally Published by RBC Global Asset Management – October 5, 2023.

The last few months have proven to be difficult for investors, with volatility spiking across asset classes.The technology sector, one of the strongest performing sectors for most of the year, has also succumbed to recent declines. Meanwhile, bond prices have fallen meaningfully as of late. Below, we address what has been going on in Fixed Income Markets and why it remains an important component in our portfolios.

Fixed income investments (bonds) typically provide stability and reduce volatility when incorporated into a portfolio. The value or price of bonds is inverse to their return or “yield” (e.g. when bond prices go lower, the yield or rate of return increases). The past month witnessed some remarkable increases in yield. Take the U.S. 10yr government bond for example. Yields on this benchmark bond rose from nearly 4.25% at the start of September to close to 5% in the last week of October marking a 16-year high (remember… yields and price move in opposite directions). The Canadian Government 10yr bond also saw yield rise over the past two months (albeit from lower absolute levels). The rise in bond yields can be traced to three main factors:^{legal bug 1}

• Stronger Economic Growth: The global economy, and the US economy specifically, continue to defy expectations and remains strong despite several headwinds to growth. One key economic data point is proving particularly resilient. Employment data is suggestive of a labour market that remains healthy with few signs of slowing down.
• U.S. Fiscal Deficit: Historically, the fiscal deficit has been contained during periods of economic strength, widening out during periods of weakness in a counter-cyclical nature. But, for the first 11 months of the 2023 fiscal year, the U.S. deficit has nearly doubled when compared to the same period in 2022. This deterioration has bond investors wondering if they should be getting paid more for this risk.
• Supply-demand imbalance: Rising yields in places like Japan and Europe, where interest rates have been extremely low (and in some cases negative), mean that the U.S. bond market now looks less attractive than it has historically. This has led to less foreign buyers of U.S. bonds. At the same time, there has been an increase in issuance of Treasuries. More supply, coupled with less demand mean yields have to rise the help the market clear the imbalance.

This Time is Different

Interestingly, rising yields have NOT been a function of increasing expectations for higher interest rates from global central banks. As you may recall, this was the main catalyst for the dramatic interest rate volatility experienced in 2022. As illustrated in the chart below, the market’s expectations for the peak fed funds rate of the next 36 months has been stable amidst all this volatility (light blue line below).

Broader Portfolio Implications

The rise in government bond yields is reverberating across more asset classes than simply fixed income markets. Most people are aware that higher rates raise interest costs for borrowers. However, these rates also influence the prices investors are willing to pay for a variety of investments. That’s because government bonds are widely regarded as being nearly “risk-free” (since governments can always increase taxes to pay the interest on the debt and are therefore very unlikely to default). This nearly “risk-free” rate often sets the minimum return investors demand from other asset classes. If you’re an investor and you see that these bonds are now yielding 4-5% versus 1-2% a few years ago, it may change how you evaluate the risk and return prospect of investing in other asset classes. This reassessment can result in a valuation adjustment on riskier asset classes, with prices that fall as bond yields rise, and vice versa.

Conclusions

While the recent market declines have been relatively systematic, periods of increased volatility are to be expected anytime you are investing your savings. Our view remains that current yields, which are near decade highs, only reinforce the appropriateness and attractiveness of having an allocation to fixed income in all but the most aggressive portfolio options at RBC InvestEase. Sustained high interest rates likely will eventually slow economic growth, and subsequently cool inflation indicating that central banks can soon end their cycle of increasing interest rates. Historically, bonds tend to perform well leading up to and following the end of a rate hiking cycle.^{legal bug 2}

Ensuring that your portfolio is appropriate for your investment objectives, time horizon and risk tolerance is essential to achieving your financial goals. At RBC InvestEase, clients have a team of talented and licensed portfolio advisors, who, in conjunction with resources from across RBC, work to ensure that portfolios are properly structured for your financial situation. Furthermore, as a client you have access to this team of professionals for advice. You can contact us by calling 1-800-769-2531 from 9:30am – 4pm Eastern time or emailing us at questions@rbcinvestease.com