When Interest Rates Fall, Bonds Prices Usually Rise, Vice Versa!!!!
As widely expected, the Bank of Canada’s governing council lowered the benchmark policy rate by half a percentage point to 3.75%. This marks the fourth consecutive cut since June and follows three quarter-point reductions. Bank of Canada Governor Tiff Macklem stated, “We took a bigger step today because inflation is now back to the 2% target, and we want to keep it close to that target.” He added, “It’s been a long road back from the high inflation we experienced coming out of the pandemic. We’re coming out the other side, and I think Canadians can breathe a sigh of relief.” Having sighed—but not in relief—and armed with the knowledge that when interest rates fall, bond prices rise, especially on the long side, we can begin today’s analysis on bonds. In the wake of this news, it came as somewhat of a surprise when we received an update from our powerful SIA AI regarding yesterday’s analytics. The SIA Asset Class ranking showed a change: the bond asset class actually declined again, this time into last (worst) place. This occurred on a day when interest rates fell and Mr. Tiff suggested that we are coming around. Remember, this also follows a massive breakout in precious metals prices, which likely ties in with this story more than anyone knows and fits well with today’s bond analysis. Fortunately, we understand that markets are extremely efficient—especially the bond market—and we might be better served to peer into what the market says rather than listening to politicians, sorry economists. The reality is that market yields are rising, and bonds continue to sell off as bids evaporate, especially at lower rates. Where once bond investors were willing to accept little return for the safety they provide, it is now clear that inflation risk remains very real. The risk isn't just about getting your money back; it’s about the purchasing power of that money continuing to implode. Smart money knows this, and the SIA platform detects it too. This is surely what the commodities markets continue to price in. Let’s consider some one-year numbers: currency futures up 24.95%, index futures up 17.54%, meat futures up 12.34%, metals futures up 21.87%, and soft futures up 23.51%. Yes, energy futures are down 16.22% over the last year, and grains are down 11.35%, but these are super sensitive commodity groups. In reality, these numbers could easily swing dramatically on even a simple winter storm—they call it “slow-release moisture” now. I digress.
Vanguard Canadian Long Term Bond Index ETF (VLB.TO)
Let’s get back to the charts, using the Vanguard Canadian Long Term Bond Index ETF as a proxy for the bond market. We’ve scaled this chart to 0.5% for sensitivity, and the result is very enlightening. Here, you’re looking at the aggregate price of long-term bonds. From 2018 to 2021, as rates declined, bond prices rose. However, in 2021, as central banks began increasing their interest rates, bond prices went into a massive tailspin, with the VLB.TO chart moving from $26 to a low of $18—a decline of about 30%. Central bankers were correct that everything did, in fact, get more expensive, including mortgage prices, but it didn’t slow the inflationary pressures, which is what the stock market was predicting. Inflated earnings grew, and stock market valuations followed, as clever investors recognized that owning a warehouse of inventory was better than any fixed-income instrument.Once citizens were convinced (or told) that inflationary pressures had diminished and the Fed could take its foot off the brake, interest rates could begin to ease. On the chart, you can see how, in 2024, bond prices finally began to reflect these upcoming cuts, rallying up to the $21 level. Super boring, right? But please stay focused and let’s turn back to the chart to see where we go from here. Prices have now rallied up to long-term resistance and appear to have completed a point-and-figure bull trap, defined as a multiple-top breakout that reverses after exceeding prior highs by one box. Yes, it’s highly possible that this rally is a trap. As we moved into the last week of bond trading before the highly anticipated rate cut, long bonds were selling off, and yesterday, on the day of the announcement, the VLB.TO share price actually added a lower price box (see red arrow) as the price fell below $21.00 to $20.98. This is very significant, as the price is now in striking distance of the positive trend line at $20.90, which now serves as a critical support on bond prices (higher yields). Other notable levels will be $20.49 and the light green box highlighted at $19.49. Resistance, on the other hand, is at $21.32 and $21.75, with long-term resistance highlighted by a light red box at $22.41. This is against a backdrop of an SIA SMAX score of only 4 out of a best possible score of 10, indicating that VLB.TO has little strength against all other asset classes, suggesting that money would be better placed elsewhere. So if bond prices are indeed under pressure and potentially headed lower, it means that market rates could actually rise rather than decline. Good luck with that Tiff!!!
Bonds Decline in the SIA Asset Class Ranking Report
Next, let’s quickly review the SIA Asset Class Rank change that occurred yesterday while the Bank of Canada Governor was claiming we could breathe a sigh of relief. In reality, this lackluster asset class declined in strength, and for bondholders, the price of the stock market got even more expensive, as did the prices of cars, homes, food, travel, fun, etc. Bonds are now in last place against all other asset classes. U.S. equity and the value of all the inventory in warehouses continue to grow, as do the values of Canadian equity and international equity. Even cash and plain vanilla commodity futures outperform bonds. There’s no need to explain this fundamentally; everything eventually comes out in the wash, and over time it will be clear what’s occurring under the hood. But one thing is clear about this efficient marketplace: inflation isn't dead so perhaps it has more to do with the printing press than with farmers and workers producing less goods.
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