The cut in Canadian interest rates on July 15 has made investing in emerging market (EM) bonds even more attractive.
With the cut, Canadian 10-year government bond yields have fallen to 1.6%,i resulting in negative real yields for investors in Canadian bonds when core inflation of 2.2%ii is factored in.
“It is now imperative for income seeking investors who have traditionally relied on Canadian bonds as a source of income to seek higher yields elsewhere, such as in much higher-yielding investment grade emerging market bonds,” says Christine Tan, Senior Portfolio Manager with Excel Investment Counsel whose Excel High Income Fund is currently yielding 5.8%.
On average, the yield on developed market bonds is currently below 2%, compared to 6% for EM bonds. The rapidly growing EM bond market has evolved into a fully integrated sector of the global bond market and is set to become a growing component of investors’ portfolios.
The Bank of Canada cut its key interest rate by a quarter of a percentage point to 0.5% on the back of lower forecasts for economic growth for 2015, which is now projected at 1.1% versus 1.9% earlier this year. This is the second rate cut for the year so far to stimulate the slowing economy. Given slower growth, it is not anticipated that interest rates would head higher anytime soon, meaning that Canadian bond yields will remain low.
Following the announcement of the rate cut, the Canadian dollar plunged to its lowest level since March 2009 when Canada was in the midst of a recession. Like interest rates, the loonie is also not expected to meaningfully recover in the foreseeable future.
“Evidently, the case for investing in EM bonds is now much more compelling,” says Tan.
Attractive Yield in Emerging Markets Relative to Developed Markets
Source: Bloomberg. As of 05/13/2015
- Bloomberg (as of July 15, 2015
- Bank of Canada (as of May 2015)