Franklin Templeton sees strong fixed-income fundamentals as central banks cut rates and tackle inflation
In an exclusive feature by Benefits and Pension Monitor, Franklin Templeton discussed the attractiveness of fixed-income fundamentals.
The fight against inflation and future policy rates have significantly influenced market returns this year, with central banks making progress toward inflation targets despite recent slowdowns.
The Bank of Canada (BoC) initiated its rate-cutting cycle with a 0.25 percent cut on June 5, reducing the overnight rate to 4.75 percent. Mortgage interest costs and rents are the main factors keeping inflation above targets, with Canadian headline inflation at 2.9 percent.
Excluding mortgage costs, inflation runs at about 2.1 percent.
In the US, the headline inflation number is 3.3 percent, with core inflation over 3.4 percent. The US Federal Reserve (the Fed) might delay rate cuts longer than the BoC due to the strength of the US economy. “The challenge of finding monetary equilibrium remains complex,” Franklin Templeton noted.
Markets anticipated multiple rate cuts earlier this year, but the Fed’s latest projections suggest only one cut toward year-end. If US growth, inflation, and employment remain strong, the Fed may not cut rates at all this year.
Canada’s economy is struggling more than the US, with slow growth, rising unemployment, and higher mortgage renewal rates. In contrast, the US benefits from its size, diversification, and long-term low lending rates.
The BoC is expected to cut rates further than the Fed but will do so gradually to avoid harming the Canadian dollar.
Both countries have deeply inverted yield curves. Central banks are likely to be patient with rate cuts while inflation remains high. However, as growth and inflation decline, yield curves are expected to normalize.
Despite rate volatility, Franklin Templeton finds fixed-income fundamentals attractive. “The setup for fixed income remains bright,” with yields at appealing levels and resilient credit spreads.
The firm prefers short-duration, high-quality paper, which offers yields not seen since 2007. High-quality corporate bonds with short maturities are well-insulated against rate volatility.
Franklin Templeton plans to maintain a neutral duration to benchmarks and will lengthen duration upon signs of economic weakness. The US dollar is favoured for its role as a volatility absorber and profitable hedge.
Reflecting on recent years, Franklin Templeton noted, “When rates started to rise, the market buckled.” Today, starting yields of five to seven percent provide a buffer against rate moves, making fixed-income assets more attractive.
