In a normal yield environment, long-term bonds come with a higher yield than shorter bonds, allowing owners to roll down the yield curve. That is, assuming the yield curve doesn’t change, long-term bonds will be discounted using a lower rate, and thus have a higher price as time goes by. However, the benefits of this roll down are highly dependant on the shape of the yield curve – the steeper it is, the greater the benefit of long-term bonds over shorter ones. With the flattening of the curve of late, long-term bonds have lost some of their luster. But given that bonds with a maturity over 15 years account for nearly 30% of the Canadian Bond Universe, we can’t just ignore this part of the curve and wait for a steepening. So where can we find the value right now?
With the Canadian 30-year yield at around 1.5% and inflation running at 2.2%, a buyer of Canada long bonds is losing 70 basis points on a real basis. Meanwhile, long-term Canadian corporates can yield you about 3.2%. But with an economic slowdown still being a possibility – last week, the Bank of Canada lowered its growth forecast, citing unexpectedly soft consumer confidence and spending – we don’t love the risk-reward trade off in the long-term corporate space. Overall, we favour a bullet approach to bond investing at the moment, but from a risk-return perspective we think provincial long bonds, which can get you a respectable 2.4% yield and which are trading at their tightest spreads versus corporates in nearly two years, are the best choice for those seeking to invest in the longer part of the curve.