Portfolios:AGF Investments:1 BOC Hike in 2018,1 or 2 Fed Hikes

By Yali N'Diaye

     OTTAWA (MNI) - With growth unlikely to accelerate in the U.S. and

decelerating in Canada, tightening by the Federal Reserve and the Bank of Canada

could prove limited to one rate hike each next year, perhaps two for the U.S.

central bank, according to AGF Investments Fixed Income Portfolio Manager Jean

Charbonneau.   

     That should translate into still low bond yields, with the U.S. 10-year

yield capped at 2.60% in 2018. It was trading around 2.39% Monday morning,

compared to 1.93% for its Canadian counterpart.

     Although the probability of a U.S. recession is minimal in the short term,

it might have to be raised for the end of 2018 or the beginning of 2019, after

nearly a decade of continuous growth, especially with the risk of a Fed policy

error, Charbonneau told MNI.

     A U.S. tax reform could boost U.S. growth in the short term, he said, but

the impact will likely be "modest", with little to no boost over the medium

term.

     The U.S. Senate and the House both passed their respective tax bills, and

now have to reconcile the two versions, with odds of a final bill being signed

by President Trump by early next year having increased.

     Overall, Charbonneau sees U.S. GDP growth ranging between 2.0% and 2.2%

next year, with inflation still not a threat, especially with technology

increasingly adding to structural forces putting downward pressure on price

growth and weakening the link between employment, wage growth, and ultimately

inflation.

     Against this backdrop, after a 25 basis point rate hike on December 13 that

is largely priced in by markets, Charbonneau only sees one, perhaps two Fed rate

hikes in 2018.

     The Fed will want to avoid triggering an inversion of the yield curve,

which would be poorly received by the market as it has historically been a

leading indicator of an economic recession, Charbonneau opined. "I don't think

the Fed will go ahead of the curve and provoke that."

     In addition, the S&P 500 is about to enter its ninth year of gains and

valuations are stretched, making markets particularly vulnerable to an

excessively aggressive Fed.

     The Bank of Canada also has reasons to remain cautious next year despite

the recent strengthening of the Canadian labor market, that culminated in an

unemployment rate falling to 5.9% in November, the lowest since February 2008,

with employment up 79,500 on the month, the largest gain since April 2012.

     But for Charbonneau, "the only case where two hikes would be considered

would be if inflation became problematic for the BOC," which he sees no evidence

of.

     Economic news for the end of the year reflect a slowdown, he argued, adding

the Canadian economy cannot afford a Canadian dollar that is too strong. Not to

mention developments around NAFTA that will keep the BOC "very cautious".

     So the Bank of Canada is unlikely to move in lockstep with the Fed, he

said, expecting only one BOC rate hike that won't happen until the second half

of 2018, an expectation that is more dovish than market expectations.

     A status quo is widely expected on December 6.

     On the issue of the sensitivity of the economy to higher interest rates

related to the elevated household debt, where the BOC finally sees progress,

with wage growth likely to help make households resilient, Charbonneau sees no

sign of improvement even as the unemployment rate has been decreasing.

     Overall, while global growth is synchronized, it shouldn't accelerate, with

the European Central Bank and the Bank of Japan policies remaining

accommodative. This should limit the risk of a spike in long-term yields.

     Still, central bank policies have reached an inflexion point with a

beginning of a normalization, while assets are currently "quite expensive,

especially stocks".

     Against this backdrop, Charbonneau keeps a higher-than-usual 6% cash in his

global portfolio, while looking for yield in emerging market debt (12% of the

portfolio). He continues to hold inflation-protected bonds (10%).

     Within emerging markets, he maintains exposure to Brazil, Russia, Mexico,

Poland, Malaysia, while he exited Hungary and Colombia.

     In Europe, where the market is "very expensive", he has an underweight,

stressing the market is vulnerable to a change of tone of the ECB, which will

eventually have to face the lack of available bonds to buy in the market as

well.

     He has some positions in peripheral countries such as Spain and Italy, and

recently added Greece, where there is a desire to stay within the euro zone and

where the carry is attractive. He particularly focused his Greek bond purchases

on the 5-year area.

--MNI Ottawa Bureau; +1 613 869-0916; email: yali.ndiaye@marketnews.com

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