Canada among investors’ favourite bets for sooner-than-expected interest rate cut

A growing chorus of investors is buying bonds from certain developed nations where they believe interest rates will be cut sooner and faster than many economists expect.

“The U.S. economy is structurally healthier and able to withstand higher rates for longer than those economies with household leverage imbalances,” said Iain Cunningham, a portfolio manager at Ninety-One Asset Management.

Investors holding those bets argue that these economies are way more exposed to higher interest rates than the U.S. due to their more elevated household debt levels, and the full effect of their tightening cycles is yet to kick in.

Household debt accounts for about 190 per cent of gross domestic product in Australia, Sweden and South Korea, according to the latest available OECD data referring to the end of 2021. That compares with a ratio of around 95 per cent in the U.S. and Germany.

Since late last year, Harvey has increased his exposure to Sweden, Norway and Australia, with the latter being the U.S.-based fund’s biggest exposure excluding Treasuries.

While Australia surprised markets this month by raising interest rates, minutes from the meeting show that the decision was a finely balanced one, given risks to the economy and employment, and Harvey doesn’t rule out cuts later this year as the economy slows. That goes against swaps pricing, which implies the key rate being lifted by an additional 54 basis points to 4.64 per cent by December before cuts begin in the second half of 2024.

Brendan Murphy, a portfolio manager at Insight Investment, which manages around US$1 trillion, is buying South Korean bonds betting the country could take a relatively big hit if global economic growth slows in the coming months.

South Korea’s central bank held policy rates unchanged for a third straight meeting in May, while reinforcing a message that another hike may be possible amid sticky inflation. Prior to the BOK’s announcement, investors and many analysts were betting on rate cuts in Korea later this year, as risks to economic growth build.

“The danger for markets, and risk assets in particular, is that central banks effectively have to sacrifice growth to get inflation back under control,” Ninety-One’s Cunningham said.

— with assistance from Alice Gledhill