Jump Play it Safe in Bonds
Playing It Safe : Avery Shenfeld , Senior Economist
Want to play it safe in bonds, but not so safe that you’ve stuck everything
in government T-bills? Here’s two timely options to consider. The first
is a screaming buy, at least relative to Canadas: the Canadian Mortgage Bond.
The 5-year, fully government guaranteed CMB now offers a spread of 19 bps
over the comparable
Canada, with no added risk.
The CMB spread widening in the last couple of months was in response to the
broader hit to credit spreads. There’s only so far that can go before
buy-and-hold investors will flood from Canadas into CMBs to pick up what is,
over its lifetime, free extra yield with no risk. As a result, we see little
chance of a further spread
widening, and lots of reasons why spreads should continue to re-tighten, as
they started to do this week. Another Government of Canada issue is also worth
a second look—inflation-linked real return bonds (RRBs), and even more
so, their US counterpart (TIPs). Not that we think central banks are seriously
departing from their inflation-fighting mandates. But in the near term, investors
may raise eyebrows as the widely publicized 12-month CPI takes a leap to the
upside. The coming jump relates to reaching the one-year anniversary of a
lull in gasoline prices in 2006 (one not to be repeated this year), and to
ongoing food price pressures, leaving core prices largely unaffected. The
news will be more dramatic stateside, with CPI headed for as high as 3.3%
by year end, and the Fed in no position to respond with hawkish talk while
cutting rates to address a blow-up in the mortgage and housing markets. In
Canada, the headline rate will also jump, but is unlikely to go much further
than 2½%, in part capturing the fact that commodities don’t look
as strong in C$ terms. While the Bank of Canada might not be cutting rates,
it too has to hold back on hawkish action amidst a credit squeeze, a soaring
C$ and a US slowdown.
Currently, the spread between nominal and real return Canadian long bonds
sits at just under 2.4%, towards the lower end of the range of the past few
years. That might not be a bad bet for long-term inflation in the context
of a trend rise in energy prices. But we could easily see markets scared into
thinking something worse
is coming during a period in which, for well justified reasons, the Bank of
Canada stays focused on core and looks the other way at headline CPI gains
that, in a world of rising oil prices, are unlikely to be reversed. In the
US$ market, a weakening dollar will also play into the hands of the inflation
alarmists, making TIPs a winner. Braver investors will be looking at buying
distressed debt on the cheap. But for those playing it safe, CMBs and RRBs
are two acronyms worth remembering.
Kuljit Singh, Accredited Mortgage Professional
Mortgage Alliance AKAL Mortgages Inc. at (416) 621-1300 or email at info@akalmortgages.com.