E27 – Credit Market Positioning for the Year Ahead

From a duration standpoint, I do expect a lot of volatility in the Treasury market. We've seen that already to start the year and you'll see it continuing for the remainder of the year. But I do think by the end of 2026, we should see yields lower than where they started. And that should lead to some positive returns. And on the spread market, you're going to see volatility in spreads as well. But we're looking for opportunities to add to credit, especially high yield. Hey, everyone. And welcome to our first podcast episode for the year 2026. Generally, I like to kick each episode off with a roundup of recent data alongside some macro thoughts. And so much of the news flow has been dominated by announcements from the White House of late. So let's just quickly recap before we get into the main topic of today's episode. To quickly summarize the announcements since the calendar turned to 2026, we've had the White House announce a proposed ban on institutional investors from purchasing single-family homes. Also, in order to government-sponsored enterprises such as Fannie Mae and Freddie Mac to purchase up to 200 billion in agency mortgage back securities or MBS, which of course, in theory, should bring down mortgage rates. Also, an announcement to force defense firms to increase capital expenditures and production by preventing them from paying dividends or conducting share buybacks. Now, take those also in consideration with the more recent announcements, including the launching of the criminal investigation into Federal Reserve Chair Jerome Powell. Also, the transferring of 30 to 50 million barrels of Venezuelan crude into US custody. And finally, rolling out plans to cap credit card interest rates at 10% effective January 20th for the period of one year. Now, we have discussed the latter point, the rolling out of a plan to cap credit card interest in our morning note. Those six announcements are in conjunction with some of the other extraordinary developments on the macro Friday, including the recent attack on Venezuela and removal of its president as well, including potential other geopolitical conflicts that could come into sharper relief. And of course, President Trump has mentioned a few countries with respect to his focus at this point. But needed to say, the shock potential remains incredibly high for this year. And I suspect that's also contributing to sustained demand for commodities. I mean, we've moved effectively from an era of free trade into a more balconized trade environment. And it makes sense that given the unpredictable geopolitical backdrop that this should be supported for metals. And that's one of the things that we have seen in terms of performance, we have seen both base and precious metals do especially well over the last couple of months. And even into 2026, we've continued to see performance in that area. And that could be tied to importers, especially when it comes to base metals like China, front loading their purchases. What's more is that we're also seeing sustained increases in demand from a few important segments when it comes to gold. And those, of course, being central bankers who are likely adding to gold as a tail risk insurance against any geopolitical and monetary shocks, monetary policy shocks, alongside retail and institutional investors who are likely hedging against concerns over fiscal dominance of monetary policy, most notably, of course, in the United States. We're not going to talk about that today. We're going to talk about important considerations for other areas, as well. In one particular area that I like to think about a lot is the credit space. And with me today, I've got the perfect guest. He's been on this podcast before and it was one of our better episodes I would like to say. That's Vashank Chowla, portfolio manager, active fixed income, here at BMoglublas at Management Vashank. Welcome to the show. Thank you for having me, Bippen. Let's start off with a quick overview of how you're framing the credit space in 2026, especially you're given the considerable geopolitical land mines that could shake things up. What are you thinking about this year? Yeah, so it's been an interesting start to the year. I mean, as you've kind of went over, we've had a lot of headlines. And surprisingly, the market hasn't really reacted in the credit space. The spreads are still very tight. We did see a little bit of spread widening out towards the end of last year in the US, but that's mostly come back in this year. But I do think the, you know, the more further along we get into the year, you are going to see opportunities to add to credit at one point, and especially in Q1, I think you're going to see that. There's a few things that might drive it. One is the new issuance market. So we had a record new issuance market last year, both in Canada and US. And we're going to see that again this year. Now so far, the new issuance has been absorbed, but I do think that there is going to be a point where investors are going to ask for wider spreads to absorb all the new issuance that we're expecting this year, especially in the tech space. We've seen the hyperscalers kind of come towards the end of last year with a lot of new issuance that led to spread widening. And I think you're going to see the same thing this year. We're expecting about 300 billion from that sector, and that's really to some spread widening. Along with that, you got to think that the headlines, especially the headlines around the Federal Reserve and whoever comes in to replace Chairman Powell, there's going to be quite a lot of volatility around that. And then we also have Kuzma coming up for renewal. And there's good, there's just a headline right before hopping on this podcast. And I think you're going to see more headlines around that going into Q2 this year. And we should see some opportunities to add to credit. So it's interesting you mentioned the Federal Reserve. And we could always talk about what the next Fed share will look like. When we might all have an idea of what that is at this point. Swaps market, you know, they're still pricing a bit of a divergence between the Fed and the Bank Canada in 2026. To sort of reinforce that message, the Fed is expected to cut twice this year starting in June. While the market believes it's actually a material chance that the Bank of Canada could end up hiking by the end of this year. How are you framing this divergence for your market? Yeah, so it's definitely interesting. The B.O.C. the next move does seem to be a rate hike. Although, I think our view on the team is that they'll probably hold for a steady for the remainder of the year. Now, I think in Canada, that's definitely should be viewed as somewhat positive for credit markets. I think, you know, stability at the B.O.C. is definitely something that's viewed with a positive light. So I do think credit markets should perform well, even with the overnight rate holding steady. I think if we did see inflation pickback up, which is not my expectation. But if we do see inflation, pickback up and the B.O.C. starts hiking rates, I think we will see some negative movements in credit spreads. And a lot of that will be just with refinancing risk, but also the mortgage market in Canada is something that I think is a little concerning. There was a start I was looking at today that, you know, mortgage rates might be 50% higher this year than they were when the mortgages that are up for renewal this year were first implemented. And that is definitely something that should be concerning for Canadian investors. So there is a risk there. I think in the U.S. we'll have to see who Trump puts in as the new Fed Chairman. It's, you know, I'm sure everyone has their views, but I think we can all agree that we should see Fed cuts for the remainder of the year. That should lead to quite a bit of steepening, especially if inflation stays somewhat sticky. And the steepening in the year curve should lead to wider spreads. There's still a lot of demand in credit, but I do think that if the Federal Reserve gets very aggressive in the cutting cycle, the long end will spike and that should lead to some pain in the credit markets, and pain in equity markets as well. So I think you could see some risk off based on that. Cash flow from gold, B.O. ETFs makes it possible. Introducing the B.O. Covered Call Spread Gold Bullion ETF, ticker ZWGD, providing monthly distributions from call option premiums, while giving investors all the portfolio stability that gold has long been trusted for. Get paid while hedging your broad market risk with ZWGD. To learn more about this strategy, visit bmogam.com. That's bmoggam.com and search for Covered Call ETFs. Let's stick with both markets and the comparison between the two. Because I think this is very, very interesting. So obviously tight credit spreads suggest limited risk premiums. And U.S. spreads have continued to consolidate, whereas we could look at the overall Canadian index spread and that side is tightest level. It's been added years. I mean, from a positioning standpoint, how are you positioning from a sector, duration, issuer selection, perspective, and both the Canadian and U.S. markets? Yes, so I'll start with the Canadian markets. And it can create an investment grade. We are overweight Canadian investment grade. You know, it is difficult to make a card to go, you know, underweight credit, just because the amount of care you do get over the government bonds. So you generally do stay overweight, but that level of overweight is definitely at the lower end of the scale. And we have quite a lot of opportunity to add, but there's actually quite a bit of opportunities within Canada and the Canadian high-yield market is where there's been a lot of opportunities over the past year and should be going forward. So when I started in this industry, about 15 years ago, you had about 20 Canadian high-yield issuers. We're at about 60 right now. So it's increased quite drastically and it used to be dominated entirely by energy. Well, now it's a lot more diversified. So we're seeing quite a lot of opportunity in the Canadian high-year market, this spread is actually somewhat wider than the US, but you actually have, I would say, better capitalized and higher quality issuers in the Canadian high-year-old market. So we've been participating in that market quite substantially, and I think we will see us continue to do so. In the Canadian IG market, a few opportunities that we are seeing are in pipelines. That's a sector that has lagged, but still, I think, very important assets in Canada, this spread pick up versus some other long bond assets is looking pretty attractive. So I do think there's opportunities there, and another sector is diversified for financials such as credit unions. So credit unions are generally smaller players in the Canadian market, but you do get a spread pick up versus the bank. So those also look quite attractive and we've been participating in that market quite often as well. And then also just one other thing, the amount of geopolitical risk that we are seeing in the market, that generally does lead to higher old prices over the long term. So I do think there's some opportunities in Canadian energy as well. Moving on to US IG. So the main sector that I'm watching right now is technology. So technology underperformed Q4 last year with all the new issuers from the hyperscalers. Either you're Google, you're Metters, you're Oracle's. Those have started to come back, but I do think you're going to continue to see new issuers out of that space and it should create an opportunity. So that's a sector I'm watching very carefully. Another sector I am watching is the media sector and we've seen a lot of M&A activity in that space. And we've heard about the Netflix pair amount and one of those M&A that is going on right now. We don't have clarity there yet, but that is going to lead to some opportunities in that sector as well. And then, Ben, you mentioned this in your opening monologue. The credit card interest cap at 10%. That led to some spread widening out in that space. And, you know, for Trump to get that implemented, he does need to go through Congress. He also said it might just be implemented for one year. So it's not entirely negative. So there's definitely some opportunities with your capital of ones, your synchrony financial, your ally. There's definitely some spread widening that occurred in that sector. And I think some opportunities that we're looking at there as well. And then just lastly on US High-Eield, we've seen some underperformance in the leisure space. So that would be your airlines, your hotel, your gaming. Delta just came out with their forecast and there was a little below expectations. And this mostly just due to the NTUS sentiment. But a lot of his companies are global credits. And the fundamentals from a credit standpoint are still solid. So I do think the sell-off is a little unwanted and there's opportunities in that sector as well. A lot to unpack there. Let's take a step back and let's look at things from a more holistic perspective. And I want to get your take on this because I think this is something that a lot of our listeners are particularly interested in, especially in the credit space. Now US Treasury yields have been in consolidation mode for the past several months. So for instance, tens have been tracking somewhere between three and three quarters and four and a quarter since last September. Be what's your take on the balance between income generation and interest rate risk at typical credit portfolio. So from a duration standpoint, I do expect a lot of volatility in the treasury market. But I do think by the end of 2026 we should see yields lower than where they started. And I think you are going to see that, you know, there's a lot of headline risk right now that will lead to opportunities to add to spreads. And I do think that should lead to some positive returns by the end of the year. So as long as you can handle the volatility, I do think you need to be overweight credit, but have some room to add. And that's kind of how we're positioned right now. Looking for ways to enhance your cash flow? We've got you covered. Bimo covered call ETFs strike a balance between cash flow and growth by selling call options on a portion of the ETF portfolio. Investors can see their investments grow in rising markets while getting paid on dividend and option premiums during outsob volatility. To learn more about this strategy or to explore our suite, visit bmogam.com. That's bmogam.com and search for covered call ETFs. We've also heard a lot about cockroaches and zombie risks in the credit market of late. And of course, most of that commentary appears to be reserved for the private credit space. But I want to get your take on this. Are you detecting any signs of issue or stress? Fundamentals have actually slightly deteriorated. I'm not concerned yet, but you have seen leverage ratios slowly take up. You've have seen interest coverage ratios slowly take down. So there is a little bit of concern. But if you actually focus in on the triple C space for a second within high yield, you're actually seeing some very attractive spreads. And you really have to be careful here when you're buying triple C credit. You have to do due diligence. It's really on a name by name basis. But there's definitely opportunities in the triple C bucket. It's actually underperformed last year on a spread basis. And I think you can find certain opportunities. So I'll just give one example of a name we're looking at. And it's in the kind of leisure travel category. It's Hurts Corrental. So that's actually somewhat of a distressed name. And they've gone through a lot of tough times. But the spread is very, very attractive right now. And there's a lot of upside to that name. If they can just get through some of their liquidity concerns, which I believe they will over the next quarter. So that's a name we're actually following quite closely. Some of the other credit analysis and research that comes across my desk. I mean, I've seen an uptick in interest when it comes to or least people writing about a barbell strategy, really pairing short duration high yield and longer dated quality bonds. Are you of the same mind or which take a different approach? I think that makes a lot of sense, especially the shorter dated high yield. Your break events on shorter dated high yield is very, very attractive. So that just means how much do you spread have to go wider before you start to lose money. And shorter dated high yield is one of the most attractive spots right now to be in. And you can take on a little more risk and add a little more yield to your portfolio by buying some shorter dated high yield. And then you can offset that risk by buying higher quality or longer duration corporate bonds. So that strategy actually does make a lot of sense. Okay. So let's talk a bit about risk management. So in a tight spread environment, I mean, what framework are tools that you rely on for downside protection, especially default prontiers like Kyle, like we've been talking about. We use CDX quite a bit to manage our risk. You know, it's one of the more liquid ways we can manage our overall credit risk profile. And we have had some on in the past. We had some to start the year. We've recently taken that off, but we do have a level in mind where we want to add it and we're not too far away from that level. So we are thinking about protecting ourselves a little bit on the downside. You know, another thing you can do is usually treasure yields and spreads are negatively correlated. So you can go overweight duration to protect yourself from a spread widen out or from a flight to quality. So now that's another thing we're thinking about as well. We're not there yet, but with all the geopolitical risk, if something, you know, something were to happen and you could see a flight to quality in that environment, you could use an overweight duration position to hedge your overweight credit position. And then lastly, I think, you know, you really right now what you really want to have, what I recommend for investors is have room to add to credit. You know, take the carry that you get in the credit right now, but make sure you have, you know, a good amount of room to add. And that's how we're positioned right now. We have quite a lot of room to add to investment grade credit, but also high yield credit. So we're looking for opportunities in that market as well. How are you approaching duration strategy amid potential volatility from Fed Chair transition and the evolving so much composition of the balance sheet? I mean, does neutral duration still make sense here? Are you looking at things a little bit differently? So right now was slightly short duration, but we are actually getting very close to levels to go neutral. Right now, we're playing the volatile in the market. So we've seen, you know, the 10 year be fairly range bound over the past little while. So our strategy is really just to play that range and, you know, add a little alpha where we can. We're not taking huge bets, but we do believe that the treasury market will continue to be range bound. There's kind of two factors going on, right? Like you have all the volatility around the headlines around the Fed, but then you also have a lot of geopolitical risk, right? So you have one side of it that can cause deals to go out and you have the other side that's going to cause deals to go in. So I do think you'll continue to have volatility and you can, if you can, you know, manage that risk, you can definitely create some alpha by managing your duration risk. So that's kind of how we're playing it right now. We're looking for an opportunity to go neutral and an opportunity actually to go long. And I think if we see you'll spike up, you'll see us go a long duration. Vashank, thank you so very much for joining us for this episode. We'd love to have you back on sometime soon. Thank you for having me anytime. Despite the fact that spreads still remain relatively tight in both the US and Canada, there will be opportunities to add to your potential credit positions within the fixed income sleeves of your portfolios. So keep an eye out for opportunities certainly as themes evolve and any merge will definitely have Vashank back on to talk about his forte, of course, in the in the credit space. Thank you all for listening. This has been episode 27. We'll be back again soon with episode 28. Thank you, Tivashang Chowla for joining us on the Open Outcry podcast, presented by BMO Global Asset Management. For additional commentary and insights, check out BMO's ETF Center at BMOETFs.com. That's BMO, ETFS.com. The viewpoints expressed by the portfolio managers represent their assessment of the markets at the time of publication. Those views are subject to change without notice at any time without any kind of notice. 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