Inflation

How a Fed Rate Cut could bolster Canada’s largest Covered Call Bond ETFs

Posted By Financial Independence Hub | September 17, 2024

By Ambrose O’Callaghan, Harvest ETFs

(Sponsor Blog)

In late August, Federal Reserve chairman Jerome Powell caused a stir among the investing community when he provided the strongest signal yet that the U.S. central bank is gearing up for interest rate cuts starting in September.

At the time of this writing, we are just one day away from that crucial decision. So what will this mean for the yield curve, the direction of the Fed, how the change in policy is affecting markets, and the implications for Harvest Premium Yield Treasury ETF (HPYT:TSX) and the Harvest Premium Yield 7-10 Year Treasury ETF (HPYM:TSX) in the final third of 2024. Let’s explore!

How does the yield curve function?

The yield curve, which is a representation of different bond yields across various maturities, can take varying shapes and curvatures. However, the most talked about is the shape of the yield curve in particularly one that’s either normal or inverted. A normal yield curve will have short-term bond yields that are lower than long-term bond yields. This encapsulates the time and risk premium associated with investing further into the future. However, in a period wherein central banks are seeking to slow economic growth/inflation, near-term rates will be raised in a manner that leads to higher short-term yields versus long-term yields. This is called an inverted yield curve, a much rarer occurrence.

Source: Bloomberg, Harvest Portfolios Group Inc., September 12, 2024

In practice, the difference between the 10-year yield versus the 2-year yield of government bonds is the go-to measure or gauge. The yield curve has been inverted for some time and became dis-inverted (Normal) in August 2024. That is a sign that shorter-term rates are coming down. This likely precedes meaningful interest rate cuts.

Source: Bloomberg, Harvest Portfolios Group Inc., September 12, 2024

What drives the Federal Reserve?

The Federal Reserve (Fed) has a dual mandate: to achieve maximum employment, and to keep prices stable. Despite taking on one of its most aggressive interest rate hiking cycles in history to regain price stability, inflation has failed to return to the target of 2%, albeit subsiding in recent months. The lower levels of inflation come with slowing economic data and weaker-than-expected jobs data, which belies the Fed’s goal of achieving maximum employment. So, what’s next?

With inflation coming down, the Fed members seem ready to cut short-term rates to alleviate the negative impact of higher interest rates on the economy. But before we get excited, it’s worth noting that the Central bank tools traditionally take time to filter through to the economy. Interest rate cuts may not have an immediate impact on the economy and broader markets but will filter over time.

Ultimately, this shift in policy should return the inverted yield curve to a normal yield curve.

Rate expectations: What is already priced in?

The next Fed rate announcement meeting is on September 18, and the market is already pricing in the first rate cut. The size of the cut is still up for debate, but it is likely to be 25 basis points, with a smaller chance that it could be larger at 50 basis points.

Looking further out to the Fed’s remaining two meetings for the rest of the year, the market expects the Fed to cut rates again. That would represent a total of 100 basis points of cuts expected by the end of 2024. Moreover, the market has priced in 10 rate cuts, or 250 basis points, of total interest rate cuts. These are priced in and expected to occur throughout 2025 with the ultimate destination of 3.00% on the overnight rate.

However, interest rates further out the yield curve have also recently moved down quite a bit. This is what’s known in bond-speak as a “bull steepening” — as the curve normalizes yields across maturities shift lower too, and thus bond prices move higher. Indeed, the narrative continues to shift toward the imminent start of this rate cutting cycle.

The 10-year yield was 3.65% at the time of writing. That is already down significantly – 137 basis points – from the peak of interest rates in October 2023.

The implications for the yield curve

What will happen to the yield curve going forward? Portfolio Manager Mike Dragosits, CFA, expects the yield curve to normalize due to several existing factors. The tightening cycle is ending, and the Fed is poised to embark on a rate-cutting cycle. So, this would mean that short-term bond yields may fall faster and stay relatively lower than long-term bond yields. Continue Reading…

Why it’s never too late to Invest your Money

Posted By Financial Independence Hub | September 16, 2024

Worried you’re behind the “Magic 8 Ball” when it comes to investing in retirement savings? If your retirement fund is a bit anemic (or nonexistent), there’s no time like the present to get started! It’s never too late to invest your money but do you know where to start? Will explore active, passive, and wise investment options in this quick guide to your financial freedom.

By Dan Coconate

Special to Financial Independence Hub

Investing is often seen as a young person’s game. But the truth is, it’s never too late to start investing your money.

This is especially relevant for retirement planners and seniors. Whether you’re planning ahead or looking to make your savings work harder, investing can play a crucial role in your financial future. Below, we take a closer look at why you should start investing, what to look for when you invest, and how to prepare your family for the future with this wise financial decision.

Is it really never too late to Invest?

Many people think investing is only for the young. But countless success stories prove otherwise. Take Colonel Sanders, for example. He started Kentucky Fried Chicken (KFC) at the age of 65. Another prime example is Ray Kroc, who expanded McDonald’s in his 50s. These stories highlight that it’s possible to achieve financial success later in life, including when you think it’s time to retire.

Certain investments work for different age groups, which makes it easier for seniors to start investing. For instance, dividend-paying stocks offer a steady income. Bonds provide low-risk options suitable for conservative investors. Even real estate is a lucrative investment at any age.

Starting later can be just as rewarding as investing early. The key is finding the right opportunities. By doing so, you can make your money work for you, irrespective of your age and stage in life.

Active vs. Passive Investments

Active investments require regular attention. Examples include actively managed mutual funds and day trading. These investments aim to outperform the market. They need more effort but can offer higher returns.

Passive investments, on the other hand, are more hands off. Index funds and ETFs are good examples. These options track market indexes and require less management. They are ideal for those who prefer a simple approach.

Understanding the differences between active and passive investments is important. By knowing your options, you can choose the one that suits your lifestyle and risk tolerance. Whether you prefer to be hands-on or hands-off, there’s an investment strategy for you.

Benefits of Investing at a Later Stage

Investing later in life offers long-term financial security. It helps grow your money and secures enough funds for retirement. A well-planned investment can provide a steady income stream and offer peace of mind. Continue Reading…

Understanding Inflation, Interest Rates, and Market Reaction

Posted By Financial Independence Hub | September 4, 2024

Markets can be Scary but more importantly, they are Resilient

LowrieFinancial.com: Canva custom creation

By Steve Lowrie, CFA

Special to the Financial Independence Hub

Most investors understand or perhaps accept the fact that they are not able to time stock markets (sell out before they go down or buy in before they advance).

The simple rationale is that stock markets are forward looking by anticipating or “pricing in” future expectations.

While the screaming negative headlines may capture attention, stock markets are looking out to what may happen well into the future.

Timing bond markets is even harder than timing stock markets

When it comes to interest rates and inflation, my observation is that the opposite is true. Most investors seem to think they can zig or zag their bond investments ahead of interest rate changes. This is perplexing, as you can easily make the case based on evidence that trying to time bond markets is even more difficult than trying to time equity markets.

Another observation is that many investors tend to be slow to over-react. Reacting to today’s deafening headlines ignores that fact that all financial markets are extremely resilient. Whether good or bad economic news, good or bad geopolitical events, markets will work themselves out and march onto new highs, albeit sometimes punctuated by sharp and unnerving declines. Put another way, declines are temporary, whereas advances are permanent. And remember, this applies to both bond and stock markets.

It is easy to understand why we might be scared about the recent headline inflation numbers and concerned about rising interest. It is very important to keep this in context, which is what we will address today.

Interest Rates are Rising (or Falling)

With interest rates in flux, what should you do? Consider this… Continue Reading…

Bad Moon a-Risin’ — The Curious Case of Missing Inflation

Posted By Financial Independence Hub | September 1, 2024

By Noah Solomon

Special to Financial Independence Hub

I see the bad moon a-risin’
I see trouble on the way
I see earthquakes and lightnin’
I see bad times today

Don’t go around tonight
Well it’s bound to take your life
There’s a bad moon on the rise

Creedence Clearwater Revival

The Curious Case of Missing Inflation

Prior to the global financial crisis of 2008, if you had asked me what would happen if the Fed and other central banks slashed rates to zero and then left them there for over a decade, I would have told you that it wouldn’t be long before the world faced a serious inflation problem. I would have been dead wrong!

The Phillips curve is an economic concept developed by A. W. Phillips that describes the relationship between inflation and unemployment. The theory holds that there is an inverse tradeoff between the two variables. All else being equal, lower unemployment leads to higher inflation, while higher unemployment is associated with lower inflation.

Phillips’ theory proved largely resilient for most of the postwar era. However, a notable exception occurred in the years following the global financial crisis (GFC). From 2009 to 2021, despite unprecedented amounts of monetary and fiscal stimulus and record low unemployment, global prices remained unexpectedly subdued.

The Evolution of the Phillips Curve

As the chart above illustrates, in the years following the GFC the Phillips curve seemed to have shifted downward. This change allowed global economies to sustain low levels of unemployment that historically would have been accompanied by runaway inflation.

The classic unemployment vs. inflation tradeoff seemed to have vanished, leaving central bankers in the enviable position of being able to leave rates at uber stimulative levels for an extended period without spurring runaway inflation. This dynamic remained in place until 2021, when the rubber of unprecedented quantities of monetary and fiscal stimulus met the road of Covid-related supply-chain disruptions. This combination brought an abrupt end to the disinflation party of the past decade, causing central banks to raise rates at a blistering pace the likes of which had not been seen since the Volcker era of the 1980s.

Declining Interest Rates: How do love thee?

The long-term effects of low inflation and record low rates on asset prices cannot be overstated. On the earnings front, low rates make it easier for consumers to borrow money for purchases, thereby increasing companies’ sales volumes and revenues. They also enhance companies’ profitability by lowering their cost of capital and making it easier for them to invest in facilities, equipment, and inventory. Lastly, higher asset prices create a virtuous cycle: they cause a wealth effect where people feel richer and more willing to spend, thereby further spurring company profits and even higher asset prices. Continue Reading…

Should you use an All-Weather portfolio?

Posted By Financial Independence Hub | August 30, 2024

By Mark and Joe

Special to the Financial Independence Hub

Stock market volatility can and will happen, which can really spook many investors.

To help with that, should you use an all-weather portfolio for changing market conditions?

Would an all-weather portfolio be best long-term?

How would I build an all-weather portfolio using Canadian ETFs?

Read on and find out our take, including the pros and cons of this all-weather investing approach.

The portfolio is designed for all seasons

If you prefer a more passive approach to investing, building an all-weather portfolio may be right for you. While this portfolio is designed to perform well during all seasons of the market, from an economic boom or bust and the messy stuff in between, we’ll see below that this approach is not without some flaws and drawbacks – just like any investing approach. Further, you could be missing out on some important aspects or assets for investing entirely.

Understanding how an all-weather portfolio works can help you to decide if this path could be right for you, or even if a blended all-weather approach could make much more sense.

What Is an All-Weather Portfolio?

Just as the name sounds, an all-weather portfolio is a portfolio that’s built to do well, regardless of changing market conditions.

This investing approach was popularized by Ray Dalio, a billionaire investor and founder of Bridgewater Associates, the largest hedge fund in the world. At the time of this post, Bridgewater currently manages over $140 billion in assets.

(FYI – this sounds very impressive of course, but we don’t invest in hedge funds and neither should you!)

Dalio’s all-weather philosophy is largely this:

Diversify your investments, hold specific asset classes in certain allocations, such that the portfolio can perform consistently throughout most economic conditions.

This includes periods of increasing volatility, rising inflation, and more. More specifically, this portfolio strategy is designed to help investors ride out four specific types of events:

Inflationary periods (rising prices)
Deflationary periods (falling prices)
Rising markets (bull/booming markets)
Falling markets (bear/busting markets)

How an All-Weather Portfolio Works

Based on back-testing, essentially Dalio and his Bridgewater team came up with a model after studying the relationship between asset class performance and changing market environments. The result of this relationship crystallized the following asset class allocation that would investors to benefit whether the market is moving up or down or sideways.

Here is the asset class breakdown:

We’ll provide more detailed funds to mimic this portfolio in a bit.

One thing you’ll realize from the portfolio above is the all-weather portfolio takes a much different approach than age-based allocations (i.e., more bonds as you get older in your portfolio), the traditional 60/40 balanced portfolio, or other popular couch potato approaches. It essentially ignores an investor’s personal need for changing risk appetite. A drawback we’ll discuss more in a bit.

The theory of the All-Weather Portfolio is that: