The bond market: Why investors should continue to expect volatility in interest rates

From the end of September 2023, U.S. and Canadian 10-year bond yields jumped 22 basis points (bps). This size of increase is rare, although not unheard of. As of October 6, 2023, the yield on the 10-year Canadian bond was 4.21% and the yield on the 10-year U.S. Treasury Bill was 4.82% — levels last experienced in 2007.

This sudden spike in bond yields over the first week of October comes on the back of a bond market that seemed dead set on pricing in lower rates. As recently as this spring, Canadian markets were pricing in interest rate cuts by the Bank of Canada (BoC) by the end of 2023. However, Mr. Young explains, “sentiment has clearly shifted. Investors are beginning to realize that central bankers may be more steadfast in maintaining a higher for longer approach to interest rates.”

The push behind higher yields is driven by numerous factors including a combination of continued positive labour data out of the U.S. and an increased supply of Treasury bonds expected to flow into the market as central banks sell holdings as part of their quantitative tightening policies.

Unexpected bond buybacks from the Bank of Japan in an attempt to contain yields in the Japanese government bond market also caught bond traders by surprise, further reinforcing the view that higher rates are a worldwide phenomenon. All of these unexpected events mean bond yields will likely remain volatile and fluctuate in larger amounts faster than previous periods.

While higher central bank policy rates have been a part of market dynamics for some time, the more pronounced jump in longer term bond yields may have a more direct impact on the underlying economy. For example, Canadian 5-year fixed rate mortgages are mostly priced off of the 5-year yield. The speed of these jumps in yields is also important. A slow march upward in yields can be digested by markets, but short-term, unexpected spikes in yields have led to ever increasing volatility in interest rates and other asset classes such as domestic and global equities.

We remain conservatively positioned across domestic and global fixed income portfolios. We expect to see continued interest rate volatility as markets come to terms with a higher for longer outlook. Our overall fixed income investment durations remain neutral to our benchmarks. We continue to position investment strategies for a steepening of the curve as moves in interest rates continue to surprise markets.

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