Hello and welcome to Download. I'm your host, Dave Richardson. And today, a special edition of the Download because we have a new guest—an old friend, but a new guest—and that is Steve Pitts, who is the Vice President and Portfolio Strategist for Fixed Income at RBC Global Asset Management. Steve, we've worked together for a long time. And really, we needed somebody to break down what's going on in fixed income right now. I think people spend too much time focused on the stock market, not enough time on fixed income. If we look at Canadians overall, Canadians hold more fixed income than equity. The average Canadian investor would be a conservative investor, about 55% bonds, 45% stocks. And when you have some of the things that are going on around the world right now, fixed income tends to be the canary in the coal mine for things that may happen in equity markets. So we wanted to get you on to go all around the world for 2025 and 2026. And Steve, the listeners are nervous because they're used to a particular set of guests, but I know you got it in you. Are you ready to go?

Ready to go, Dave. Look forward to it. Yeah, the exciting world of fixed income.

Well, the people who are watching on YouTube will already find out that you're better looking than most of the guests that we have. So that's a good thing. And you've got that radio voice for those listening on the podcast. Don't forget to subscribe to us wherever you get your podcast and if you're on YouTube. And we love a glowing five-star review for Steve's fabulous appearance today and for his fabulous informations. So Steve, why don't we look back at 2025? We were talking a little bit before we started taping, and you had some thoughts on what we can take away from the experience in fixed income in last year.

Yeah. So looking back at 2025, it was a mixed year for bonds, I would say. One of the themes we did see is actually the volatility of bond yields outside of what we saw in April was fairly low. And in fact, as you got into the last few months of the year, the 10-year bond yield ranged between 4 and 4.20%. It was a pretty tight range. If you look at other volatility measures like the Move index, which is the treasury version of the VIX index, it had been elevated around 2022 and has moved down back to pre-COVID levels. If you look at the performance of bonds, it was, again, more mixed. If you're in the shorter end of the curve, that part of the curve benefited from the Bank of Canada cutting interest rates. And so we saw 3.8 to 4% gains on the short end. The long end was a little different as you saw yields increased on the long end. So you got this twist in the yield curve where yields came down in the short end, and it went up a bit on the long end. Again, the short end is really driven by what the Bank of Canada is doing in terms of cutting rates. But the long end is often driven by other factors. And this year, when we saw around the world with the increase in fiscal spending, maybe a bit stickier inflation and the result in need for more debt issuance to support that. There was concerns about that, and we saw yields in the long end tick up as a result of that. And so if you look around the world, really, US Treasuries was the best performer for the year, which is a bit surprising given what we went through in April and the narrative around foreign investors selling US Treasuries. That ended up not coming to pass in the longer term. US Treasuries were actually the best performers. Canada was in the middle, and Japan was actually amongst one of the weaker ones, again, with yields going up, particularly in the long end of the curve there. So again, you got a little bit of a coupon, maybe a little bit less than coupon on something longer term because of that weakness in the longer end of the curve overall around the world.

If I look at different diversified bond portfolios—and we talked to Sarah Riopelle a couple of episodes ago with respect to fixed income within the context of an overall portfolio of stocks and bonds—it was a pretty boring portfolio for bonds. I mean, almost a throwback to the 1990s—when Steve and I were in our heyday in Toronto and our careers were promising, until they ended up here—but where short-term government bonds became the place to be, and then you can't get a whole lot more boring than US treasuries for that. So it wasn't a great and exciting year to be a bond manager, because all the different things you can do across credit and in different parts of the world, you weren't really doing as much last year.

Yeah, it's true. In some ways, boring is good for bonds. You want bonds to be the boring part of your portfolio, as much as I hate to say, especially after the last few years. I'll take a year of boring. But to your point, without a lot of volatility, there's not as much that active managers can do to take advantage of that. The one thing you also got, too, which really helped was on the credit side, you did see spreads narrow in after widening out in the period around Liberation day. Tariffs, they did end up for the year pretty much narrow, whether you're looking at investment grade, high yield or EM. And that came against a backdrop of really record issuance in the Canadian corporate market. We saw a record corporate issuance and pretty high corporate issuance in the US as well, with both investment grade and high yield.

Yeah, and you probably get the same comment from your friends and family. I know my wife would certainly say, boring but good is a very good description of me.

Exactly.

I'm cool as a banker, but in the rest of the world, I'd be considered boring and good. So that's 2025. As we move into 2026, we've already had a little bit of excitement in fixed-income markets. So where do you want to start in terms of what we've seen already? Or maybe you want to set the context. Before we go into 2026, let's set the context around interest rates overall and expectations for this year of where things move.

Sure. Well, I think if you look at our forecast for our different bonds in both Canada, US and even around the world, we don't have a very strong directional view, I would say, in terms of yields. And so for the most part, we're expecting yields to end up pretty close to where they are today. So again, it looks like another year where it could be this coupon-type returns, although, again, things happen along the way. But again, I would say it's not a bad thing for bonds. Oftentimes, people really want that big return from bonds, but you pay for that. The best you can get on a bond portfolio is getting your coupon and your principal back at maturity. And so if you get the big capital gain, you end up borrowing from the future, if you will, in terms of returns. I would say, no strong directional view. The Bank of Canada is likely at the end of its cutting cycle here. The market's not really pricing in any more cuts. Probably get a couple more from the Fed. I think depending on what happens with the economy and the renegotiation of CUSMA, we'd probably be biased to more likely see perhaps one or two more cuts from the Bank of Canada, potentially, if things do weaken. And I think that's an important point, too, for bonds. While we don't expect much in terms of yield changes, I think the caveat would be that if you did see some weakness in the economy, weakness in the labor market, that's where you could see more aggressive cuts from Bank of Canada, from the Fed, and yields coming down. And that's, I think, where you'd get more of those gains and that ballast within your portfolio.

Yeah. And we always talk about bonds and the traditional role that bonds play. Of course, generating income. Somewhat stable income over time. But also as an offset to what's going on in your stock portfolio. So I know when I'm talking to investors and advisors across Canada, they often express concern when markets are at all-time highs. Obviously, we have a different type of president in the US with a different approach, particularly to communication or maybe dealing with friends. So that unnerves markets. Having the protection or the insurance, the classic insurance of bonds is important. And then depending on how much risk you're taking in your portfolio, as you say, the boring-is-good is a great line to say you can have those bonds as the offset to the volatility you'll see in equities. And then if you're a more conservative investor, it's going to create a lot more comfort for you coming into the year we're going to have.

Yeah. And to your point, how you structure your bond portfolio. I would say there's three main objectives for bonds. It can be stability, equity diversification, and income. And it's almost like a triangle, and what bond you own tilts you toward one of those three objectives. If you really want to focus more on that equity diversification, you want higher quality bonds, maybe a bit longer term bonds. If you want more focus on income, you'd have more credit. If you want a bit more stability, it might be more shorter-end bonds. And as you move toward each of those points, you move away from the other ones. So there's always this trade-off between those three. The one thing I would say, though, I talked about the yield curve steeper now, and it is a bit of a different environment than what we've been used to in the last couple of years because it's been a very flat yield curve environment for a couple of years. You haven't been paid to go further out the curve. And so it's been easy to stay in cash because cash has given you the same yield that a 10-year bond was getting. But today, you are getting paid to go further out the curve in bonds, which I think is an important differentiator because two years ago, if you wanted to get a better yield, the only option was credit. But now, for example, our flagship RBC Bond Fund has a yield of 3.8 versus our money market fund of 2.2%. So you can get almost double the yield now from a bond fund versus from a money market fund. So I think that's a bit different than what we've seen in the last couple of years. So I think an important feature to highlight of the bond market today, too, I think.

Yeah. So that's interesting. And one of the other things off steeper yield curve, and you've already seen it over the last several months, is financial stocks start to look fairly attractive. And you've got that steepening yield curve in most developed markets around the world, even some of the emerging markets. And that creates some opportunities, as we've talked about with several of the other portfolio managers who are managing money in the equity space all around the world. So then, Steve, if we move out to high-grade corporate, Canada, US, and in other parts of the world, is that looking like an attractive space? Because you said that with the steepening yield curve, we actually do get rewarded a little bit for going a little bit longer. But are we going to start to see where we get rewarded somewhere in the world in that high-grade corporate space?

Yeah. So in general, I would say the fundamentals are really good in credit. We have a pretty solid economic backdrop here. The profits are strong. There's not a lot of distress, if you will, in the system. So I would say for investment grade and even higher yielding debt, fundamentals are good and the technicals are pretty good. There's very strong flows, strong demand for credit today, and that's why you're seeing this increase in issuance. I know our colleagues in the US have talked about this element of the rising corporate issuance in the US, expected from some of the hyperscalers, for example, are going to be coming to the market. And so we could see US corporate issuance hit a trillion dollars this year versus, I think it was 600 billion last year, something like that. And so there is going to be a lot of issuance. So far, it's been met with pretty strong demand, I would say. The one concern is that you have pretty tight spreads in terms of that risk compensation you're getting for credit pretty much across the board, whether that be investment grade, high yield or EM, is lower relative to average. That doesn't mean you need to abandon it. It just means that you don't have as much of a buffer built in there. If something does go wrong, if something unexpected happens within the economy, you could see spreads widen out a little bit and credit underperform. But overall, I would say within a lot of our portfolios, we do still maintain an overweight to credit position, more so in a lot of our funds in the shorter end, that one-to-five-year end, where you have a little less vulnerability, more higher probability of outperforming there. But I think you often see for credit that you can stay at fairly tight levels for long periods of time. When you get to these points, it's important, I think, to still have that allocation, but I think this is the point in the cycle, too, where active management can be valuable. This is where your credit team comes in to really pick and choose where you go within the credit market. I think it's a part of the cycle where that becomes perhaps a bit more important to be a bit more selective out there.

Yeah. I really think because it is such a dull market and spreads are so narrow, but the geopolitical backdrop, as we could say, you could probably even say it's almost crazy or nothing like we've ever seen before. So you never know when something's going to happen, where those spreads pop out. And we should do some defining here. If you think of government credit as being the lowest risk. The Canadian government never missed a bond payment. When we buy a bond, we're lending money to whoever we're buying the bond from. So if we lend money to the Canadian government, they're extremely reliable. So the interest, the yield is going to be at a particular level. If we're lending money to Argentina, which defaults every 10 years or so, then we might demand a higher rate. So think of it as if I was lending Steve $20, a very reliable guy, as you can see on the podcast here, I would expect to see that $20. So I would just say, give me $20 tomorrow. Steve repays it. Some of our friends, Steve, we know who are much less reliable. Give the $20 and you may see it or not. So you say, well, I'm going to give you $20, but when you give it back to me a year from now, you're going to give me $30. Because they're a higher risk. So we're going to expect a little bit more back on the other end. And that's the difference in terms of credit levels from government to corporate grade to high yield. An oversimplification. But what happens when you've got that political instability is, well, at some point we get some noise in the background—say somebody is going to invade Greenland—and that creates some concerns that that's going to hurt the global economy because of all the uncertainty. And all of a sudden, for some of those riskier bonds, the yield goes higher. And what that does if you're an active manager—and this is why active management is so important in fixed income—is that active manager versus an index can go and shift the weighting from the lower risk to the higher risk, so that when ultimately the noise is down, the angst goes down, that nervousness level, the yield drops down. And of course, when yields drop, the price of the bond goes up, and that's where you make money in the bond market. And so that backdrop that we have geo-politically creates these short-term spikes of volatility and move in the spread, which really creates some exciting opportunities if you can get access to them. And that's where a big active manager adds value.

Yeah, for sure. And to your point, when you're an active manager, and especially our teams have a two, three-year time horizon, they're thinking, well, spreads are tight today. There's probably going to be over the next 18 to 24 months of time where I can get in at perhaps a better valuation. So if you think of a range of allocation to investment grade, I might be at the lower range today, and then as spreads widen out, there is an opportunity to transition into that. So that tends to be how we're thinking of it. And again, I will say to your point, with investment-grade bonds, high-quality corporate bonds, it's very rare you get an actual default in that part of the market. It's because you're talking Canadian banks, pipelines, telecom companies, very high-quality companies that the risk tends to be more just the volatility around that risk premium that you're getting.

Now, going back to my analogy of reliable friends. So Steve, I said extremely reliable. Give him 20 bucks so we can go and buy lunch. And I know I'm getting it back next day or the next time I see him. But if I were to lend Steve a trillion dollars, again, as reliable as he is, I might start to, at some point, get worried that a trillion dollars is a lot for Steve to repay me. And that ties to the US economy, which is carrying 38 trillion dollars of debt. And the Japanese economy, Japan, which is carrying, I think it's north of 250% of debt to GDP ratio. And we've seen some activity at the longer end of the yield curve in the US and Japan that has been particularly interesting early in the year. So with that set up, why don't you tell me how you're going to repay the trillion dollars, Steve, or tell me how Japan and the US are going to manage repaying all these trillions of dollars.

Well, we'll start with the US. It seems some volatility around that longer end. And what you're seeing is really that concern. If you're a longer-term treasury investor, concern about not the viability, but the willingness of the US government to repay you. And if you get some unease about that, that does lead to some volatility, some capital flows out of the US. If they lose trust in the government, that's important. If you're a bond investor investing for 30 years in a government, you have to have some level of trust. And if that starts to erode, that's where you can see those yields move, particularly at the longer end. And so we have seen that a little bit recently. It's with the reversal on Greenland, we've started to see yesterday and today, the long end started to come down in the US. And just to look at the 10-year, we’re back above that 4.20 level. Japan has been an interesting story. Historically, we've seen Japan yields very low. Inflation. It's been battling deflation for the last number of decades. But now, really, every other developed market country has been raising rates to fight inflation. Japan has been much slower to do that. And so you've started to see, for example, a 30-year Japanese government bond, a JGB, has moved from, I think it was around 1.5% a couple of years ago to 3.7% today, somewhere in there. So we've seen this big rise in the long end for Japanese government bonds. And a couple of things driving that. You've started to see the Bank of Japan hiking interest rates, with expectations that that will likely continue. And they also have a new Prime Minister that has been very pro-growth. And so there's been concern about more fiscal spending, to your point, adding on to that already fairly large debt load in Japan. And so as a result of that, we have seen yields on the longer term rise quite markedly in Japan. I think even the last year, it's been over 100 basis points, which is big for a 30-year bond that doesn't tend to move quite as much. I would say, though, at these levels, a lot of our investment teams are thinking that it's actually fairly attractive, and we've been adding a little bit in some of the mandates to that longer end of the market in Japan, and especially if you consider the benefit you get from hedging. So if you're buying the JGB, you actually also get a positive carry on the currency hedge. So on a currency hedge basis, you're getting over 5% now on a 30-year Japan government bond. So it's pretty attractive yield compared to in Canada, 3.6. And even on US high yield, you're getting, on a hedge basis back to Canada, something close to 5%. So we do think that yields are attractive there. I think for things to get worse, you would have to think that Japan turns into an emerging market country and has a currency crisis. But we don't really see that happening. There might be some continued volatility. But if you look at what the market is pricing in over the next number of years, it's pretty aggressive. I think the market is pricing in the Japan 10-year bond, 10 years from now, to be 4.2% or something like that, which is very high. And we don't think policy rates are going to be anywhere near that. Japan still is a very low growth country. So anyways, there has been some volatility there. If anything, we think the risk premium you're getting is actually pretty decent in the long end of the Japanese market today, and not something we necessarily expect to continue for a long period of time.

Yeah, and just to put the Japan-US thing in perspective, say I'm a relatively successful person in Canada, good, steady job, high income. I get into the housing market. I buy a house that is suitable for me and my family. So I'm probably paying two or three million dollars for that. So I might be carrying a fairly large mortgage. If I just had a five-year mortgage mature in Canada, the rate was around 1.5% on my five year before, and now I'm going to renew into a rate in around 4%. And again, my payment goes from, I don't know, a thousand to $2,500. Now, I much preferred the thousand. That was a lot better. I can still afford the $2,500, but it does change my lifestyle. It has an impact across other financial decisions I'm making. And that's what Japan is facing. When those rates go up, you've got all this debt. Now you have to pay more to service that debt, just like you're paying the mortgage. And so it constrains your options in terms of what you want to do as a government to drive economic growth or support the economy. And so that's what Japan, very high debt, the US, very high, not quite as much, but very high. These countries have huge tax bases. They generate huge amounts of revenue. So no reason to believe they're not going to be able to service that debt, but it does start to constrain their options in terms of government policy.

Yeah, it's certainly that cost factor, to your point, as bonds mature and they're reissuing new bonds at those higher coupons. The US is facing that. A lot of countries are facing that, but certainly in Japan, where you've seen a pretty big move, that's something that's come into play. The other factor, too, is I think the Japan Ministry of Finance has been slow to adjust where they're issuing as well. They've issued a lot in the longer term and historically, local players, and to some extent, the central banks have been buying some of those bonds as well, but they're doing less of that. And so in our view, they've been a little bit slow to adjust. They've started to now adjust the issuance, moving it a bit. So I think that might help the situation as well.

And that's a big thing, again, with all the noise around the US economy that you don't hear enough about, if we're talking specifically about bonds, the US has made that pivot to issuing that shorter term debt. And that, again, helps the cost and gives a little bit more flexibility in the near term around the economy to hopefully increase growth, rates continue to come down, and start to at least do something about their debt and deficit over the next few years. So we have seen that in the US. Go ahead, Steve.

The US administration, while they talk about cutting interest rates, they're really keen to cut mortgage rates. And if you want to do that, you need the long end to come down because a lot of mortgages in the US are at that 30-year term. And so the risk is, if Trump pushes for cuts in the short under the curve, that actually could work against the long-end, and you actually could see the long-end go up as a result of that. So whoever gets put into that spot as Fed chair, it has to be mindful of the implications of, really, if you want that long-end, you want to maintain that credibility, maintain that inflation-fighting narrative at the short-end as well.

Let's just finish off, Steve, with just a quick summary on the Canadian bond market in terms of rates and credit. You talked about potential cuts from the Bank of Canada, and then similar in Canada to other the world, maybe we see some creep at the longer end. But what's the expectation and where do you see the sweet spot being in the Canadian bond market in 2026?

So I think it is probably a market where you're getting similar 3.5, 4% type returns on bonds. And then again, I think from a credit perspective, we do like the shorter end of the credit curve in particular. So the one thing I would say is it is a pretty attractive time relative to the last number of years to be owning bonds, given where yields are. You might remember 10 years ago, yields were closer to 2%. And so we've gone through this period where yields have normalized. Yields are your best predictor of future return. And so yields today are, like I said, on our bond fund, just under 4%. So you're in a spot where you're getting good income on bonds today. And I think that's one of the reasons you're owning it. And, importantly, I think the bonds will act as a good ballast against the equity part of your portfolio if you do see some volatility. We do like the opportunity in bonds today. Might be boring, but I think it's that important part of your portfolio, though, that I think helps you sleep at night, really, within the context of your overall portfolio.

Well, that's why I wanted to have you to do that summary, Steve. A fantastic job. We covered a lot of ground in 30 minutes. Thanks for agreeing to do this. I hope you'll come back. Was it a good enough experience? You'll come again?

It was okay. No, it was great. Yeah, I appreciate it.

Even if I come down to your desk and demand my $20 immediately?

Last time I borrowed 20, you were asking for 30 back.

Well, we are focused on returns, which is why we do this podcast. Steve, thanks for joining us, and we'll see you soon.