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Decreased Rates Provide Tailwind For Fixed Income

While fixed income underperformed in 2022 due to the aggressive rate hiking cycles by central banks, fixed income portfolios could perform very well if the Bank of Canada stops hiking rates or even starts cutting interest rates due to a slowdown or recession,” says Thomas Reithinger, fixed income portfolio manager at Capital Group. When the economy slows, central banks are more likely to decrease interest rates, which would give a tailwind to fixed income – especially government and provincial bonds. He anticipates that the Canadian economy will slow enough for the Bank of Canada (BoC) to stop hiking rates in 2023, positively impacting fixed income returns. “However, I am uncertain if Canada will enter a recession, which happens when households and businesses lose confidence in the outlook. There are currently no signs of that happening yet, but the probability is rising in 2023,” he says. The two biggest factors impacting BoC policy in 2023 are the resilient Canadian labour market and the risk that Canada could slow down if Europe goes into recession due to the gas crisis and war in Ukraine. As there are signs that hiring is slowing, if the unemployment rate starts increasing meaningfully that will likely make the BoC more comfortable cutting rates to support the economy, giving tailwinds to fixed income. However, if Canada continues to see labour market strength in 2023, there is evidence that inflation will not decrease and the BoC will have to raise rates further. These make having a well-diversified fixed income portfolio important in 2023, he says.

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