Market Commentary
During the third quarter of 2024 ("Q3"), markets began pricing in aggressive Federal Reserve ("Fed") rate cuts despite strong U.S. economic data and persistently high inflation. This outlook stemmed from a theoretical ‘neutral rate’ presumed to be well below the Fed funds rate, suggesting that the Fed needed to lower rates swiftly to avoid significant economic damage. Consequently, U.S. long yields fell sharply, with the U.S. Treasury 10-year yield declining from 4.39% at the beginning of Q3 to 3.79% by quarter-end, a drop of 60 basis points (bps).
On September 18, the Fed reduced the Fed funds rate by 50 bps to a range of 4.75% - 5.00%. Around the same period, the 10-year yield reached a low of approximately 3.60%. Despite this, market expectations remained for an additional 200 basis points of cuts by the end of 2025.
This action by the Fed and subsequent market positioning appears questionable. If the current Fed funds rate was substantially above the ‘neutral rate,’ financial conditions would have been restrictive—yet this was clearly not the case, with major U.S. stock indices reaching new highs and commodity prices, including gold, establishing clear upward trends. Asset price strength was bolstered by high levels of household income, including interest income and capital gains, indicating that the Fed funds rate remained far from restrictive.
As of this writing, Q3 U.S. real Gross Domestic Product ("GDP") grew at an annualized 2.8%, surpassing both trend and potential growth rates and providing a growth backdrop likely to sustain inflation. Inventory drawdowns, driven by strong consumption, imply businesses will need to replenish inventories, contributing to future growth. The trade deficit, driven by higher imports, further indicates strong demand and consumption.
Market positioning appeared misaligned when, shortly after the Fed’s September 18 rate cut, the U.S. Treasury 10-year yield began to rise, ultimately reaching 4.38% in response to strong U.S. growth data and renewed inflation pressures.
The Bank of Canada (BOC) also cut its policy interest rate twice in Q3, by a quarter-point each on July 24 and September 4, bringing the target rate to 4.25%. Another 50-basis-point cut followed on October 23, lowering the target to 3.75% as a proactive measure against further demand weakness in the Canadian economy.
Inflation is expected to remain more persistent than consensus forecasts, given substantial U.S. budget deficits and stock indices near all-time highs. The resilience of the U.S. economy suggests further room for U.S. and Canadian bond yields to rise in the near term.
Comparatively, while the Canadian economy exhibits some relative weakness against the U.S., overall growth has remained positive, likely aided by strength in the resource sectors.
Fund Positioning
The Tactical Sovereign Bond Fund underperformed its benchmark in Q3, posting a return of 0.1% versus an index return of 4.0%. At the end of Q3, the Fund's Effective Duration remained at 0.1.
This underperformance primarily reflected the Fund’s short duration strategy, which was less favourable amid the quarter's market conditions, despite engagement in ‘tradable rallies’ within the bond market.
With robust economic fundamentals, U.S. rate cut expectations may be significantly tempered, particularly compared to Canada. As U.S. Treasury yields rise and the interest rate differential widens against Canadian yields, the U.S. dollar is likely to appreciate against the Canadian dollar. As of the end of Q3, the Fund is 54% in U.S. dollars.
The current strategy is expected to continue through Q4 2024, contingent upon shifts in macroeconomic indicators, geopolitical developments, the U.S. election, or financial disruptions.
While capital preservation remains a key tenet of the Fund’s strategy, the Fund benefits from its ability to capitalize on evolving market dynamics within bond and currency markets.
1Series F, total return CAD terms
2Duration is a measure of the sensitivity of the price of a bond to a change in interest rates. A fixed income security (or fund) with a higher (longer) duration would indicate a higher sensitivity to interest rates and thus, higher interest rate risk.
Standard performance as at September 30, 2024.
| Company | 1 Year | 3 Year | Since Reorganization3 (August 27, 2018) |
5 Year | Since Inception (July 25, 2016) |
|---|---|---|---|---|---|
| Caldwell Tactical Sovereign Bond Fund Series F | 3.1% | 1.1% | 1.1% | 0.5% | 0.4% |
| S&P Canadian Sovereign Bond Total Return Index | 8.7% | 0.1% | 1.4% | 0.2% | 0.7% |
3The Fund, following a security holder vote, changed its fundamental investment objective August 27, 2018 and also reclassified former Series I units to the current Series F. For more information refer to the Simplified Prospectus of the Fund.
The information contained herein provides general information about the Fund at a point in time. Investors are strongly encouraged to consult with a financial advisor and review the Simplified Prospectus and Fund Facts documents carefully prior to making investment decisions about the Fund. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Rates of returns, unless otherwise indicated, are the historical annual compounded returns including changes in unit value and reinvestment of all distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any unitholder that would have reduced returns. Mutual funds are not guaranteed; their values change frequently and past performance may not be repeated.
Publication date: November 7, 2024.