Fixed income portfolio manager at MFS Investment Management explains why pension funds should brace for stability and rethink fixed income allocations after Wednesday's rate announcement
The Bank of Canada’s latest Monetary Policy Report (MPR) took a rather unconventional turn. Rather than laying out a clear base case, the central bank is leaning into the uncertainty of trade policy, using a current tariff scenario as its foundational outlook.
Soami Kohly sees the Bank of Canada's latest decision to build its MPR around a current tariff scenario as a notable shift in how the central bank is approaching uncertainty. Unlike previous reports that presented multiple potential outcomes, this time the Bank leaned into a single, highly conditional narrative. Kohly attributes that to the binary nature of tariffs which are not gradual economic developments.
“In the last MPR, they had two scenarios: a non-tariff and a tariff scenario. What I found interesting here is they just went with the tariff one. It’s like a light switch. It’s on or off, and we don’t know what’s going to happen,” noted Kohly, fixed income portfolio manager and investment officer at MFS Investment Management.
What stood out to Kohly this time around was the central bank’s prediction of a 1.5 per cent contraction in GDP in Q2 alongside inflation just above 3 per cent. Based on that outlook, he questions the decision not to cut rates immediately.
“If they think that's going to happen, and they had to cut because of that, they should have cut today,” he said.
The implication, as Kohly suggests, is that the Bank may be signaling an end to its rate-cutting cycle at least for now. If policymakers are anticipating economic contraction and still choosing to hold, he believes it would take a deeper and more prolonged slowdown to justify further easing. That could push the next rate decision well past September unless economic data takes a sharp turn. Still, Kohly expects the BoC to cut at least once this year if they choose, with an ideal overnight rate hovering around 2 per cent.
Kohly noted that while US monetary policy is typically more aggressive on both the tightening and easing sides, Canada has taken the lead recently in cutting rates. Still, he doesn’t see an urgent reason for the Bank of Canada to continue easing.
“We’re not in a recession. The US is not in a recession. And inflation in Canada is still on the higher end of the range. There’s not a burning need to cut as of now,” he said. "There's nothing stopping the Bank of Canada from doing jumbo cut. They can do 50 basis points at a time.But right now, they don't need to do anything."
While short-term economic forecasts don’t typically alter the core investment strategies of pension funds, they can shift geographic or asset-specific allocations, noted Kohly, adding that what it might affect is “where they invest. That might be more on the equity side, quite frankly,” he emphasized, particularly when monetary policy trends differ across regions and influence equity valuations.
Additionally, from an investor’s standpoint, the current rate environment is opening opportunities that haven’t been available in more than a decade. For institutional - and retail investors - Kohly emphasized that high-quality fixed income is now offering solid returns without forcing a trade-off in liquidity or credit quality, noting that this is a significant shift from the post-financial crisis era, when comparable returns required moving into high yield or illiquid private assets.
In the interim, Kohly suggests the best approach for pension funds right now is to maintain a moderate level of risk exposure while preparing for flexibility. Despite ongoing uncertainty around trade and rates, he believes staying slightly overweight in equities is appropriate.
“The way that we've been positioned, even with all these risks, is that we are slightly overweight equities relative to our benchmark but we're on the lower end of what we consider risk on,” he said.
“To me, I think that's a good position to be in because the US economy is fine and that means the Canadian economy generally is fine, and it generally means the world economy isn’t doing that bad either. That's the reality of how it works. I feel like people have been waiting and waiting for some shoe to drop since 2022,” he added, referencing repeated recession calls that haven’t panned out. In his view, risk exposure, if sized appropriately, tends to outperform over time.
“Risk tends to win,” he said. “You have to be selective in how you take the risk and how much risk. In this environment, still with the uncertainty we have, you still want to be overweight risk, whatever that means for you, whether that's a fixed income portfolio, whether it's a balanced fund, but probably on the lower range, just given the amount of uncertainty.”
Over the long-term, Kohly sees strong structural demand building for long-duration corporate bonds among pension funds and insurance companies, both of which face long-dated liabilities. He underscored that demand is beginning to overwhelm supply in the Canadian market.
Even though spreads on long corporate bonds are historically tight, he argued the total return that institutional investors are getting on long corporate bonds “is very, very attractive,” acknowledging the technical demand driving this rally doesn’t appear to be fading until long-end interest rates fall.
Kohly ultimately believes Canada’s close economic ties to the US are still shaping domestic monetary policy, even as the Bank of Canada projects a contraction in GDP, while longer term, he thinks diversification away from the US could weaken that correlation. For now, however, “in the near term, it has to be pretty correlated,” he noted.
Given the strength of the US economy, he’s reconsidering his expectations for further rate cuts in Canada.
“Maybe it means that the Bank of Canada is not going to have to cut anymore,” Kohly said, noting this wasn’t his original view heading into the latest MPR. “The last time I looked, the market was still pricing in two cuts for the end of the year. And given the MPR, that may be too high,” he said.
He also acknowledged his earlier belief that Canada would be treated more favorably in US trade negotiations may have been misplaced. With other countries already securing agreements, Canada could end up at a disadvantage.
“If every other country has trade deals done, and we're the last country standing, it's a little more difficult for us,” said Kohly.
