Canada’s fixed income markets at a crossroads as rates fall
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Franklin Templeton’s Darcy Briggs sees credit strains, currency weakness, and trade tensions reshaping Canada’s fixed income outlook in 2025
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BOND MARKETS are bracing for heightened volatility. Treasury yields are poised for sharp swings in the coming weeks, driven by policy uncertainty out of Washington and a steady stream of critical economic data on growth, employment, and inflation.
The Trump administration’s unpredictable blend of tariffs and budget cuts has rattled many everyday investors, prompting them to rethink the long-standing belief that staying the course in equities is always the safest bet.
Forecasting the Federal Reserve’s next move has become increasingly difficult. Canadian bond investors are contending with slowing domestic growth, reshaping expectations for yields and returns. The intersection of growth, inflation, and government policy influences on them sets the tone for bond markets, while currencies act as a kind of relief valve, adjusting to differences in economic performance and monetary policy between countries.
This relationship is at the centre of Darcy Briggs’ and the Canadian Fixed Income Team’s analysis at Franklin Templeton Canada. As a lead portfolio manager at the firm, Briggs oversees its Canadian fixed income strategies and has spent much of the past year navigating what he calls a “stealth recession” in Canada. “The US economy has outperformed Canada and looks set to continue doing so,” Briggs says. “The rate differential between the two countries favours the US, and that’s generally a headwind for the Canadian dollar. Even without tariffs, we’d still be facing significant structural challenges here at home.”
Franklin Resources, Inc. [NYSE:BEN] is a global investment management organization with subsidiaries operating as Franklin Templeton and serving clients in over 150 countries. In Canada, the company’s subsidiary is Franklin Templeton Investments Corp., which operates as Franklin Templeton Canada. Franklin Templeton’s mission is to help clients achieve better outcomes through investment management expertise, wealth management, and technology solutions. Through its specialist investment managers, the company offers specialization on a global scale, bringing extensive capabilities in fixed income, equity, alternatives, and multi-asset solutions. With approximately 1,300 investment professionals and offices in major financial markets around the world, the California-based company has over 75 years of investment experience and over US$1.5 trillion (approximately CAN$2.1 trillion) in assets under management as of January 31, 2025.
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Canada vs. U.S. growth – GDP (YOY % change)
15%
“If you strip out government stimulus and immigration, Canada’s GDP per capita has been flatlining for almost a decade. It looks like we’re growing, but we’re really just treading water”
Darcy Briggs,
Franklin Templeton
As fixed income investors assess the path forward, they are grappling with questions that were once theoretical but are now pressing: How low will rates go? How much risk remains in credit markets? And how will tariffs and global trade tensions reshape the outlook? According to Briggs, active management is no longer optional – it’s essential.
Beneath the surface of Canada’s headline growth numbers lies a more fragile reality. Briggs states that much of Canada’s recent economic resilience has been driven by two factors: large-scale government spending and rapid population growth through immigration. While these forces have kept aggregate demand afloat, they have masked underlying weakness.
“If you strip out government stimulus and immigration, Canada’s GDP per capita has been flatlining for almost a decade,” Briggs says. “It looks like we’re growing, but we’re really just treading water.”
The vulnerability becomes clear when examining the pressures on the Canadian consumer. Thousands of
households that took advantage of ultra-low interest rates during the pandemic are now facing mortgage renewals at substantially higher rates. Many of these borrowers locked in five-year terms at rates between 1.75% and 2.50%. Today, they are looking at renewal rates closer to 3.50% to 4.00% – a significant jump that Briggs warns will create a sharp increase in household debt service costs.
“Even with rates coming down from their peaks, homeowners are facing payment shocks,” he explains. “If your mortgage payment rises by $300 to $500 a month, that’s money that’s no longer available for discretionary spending.”
The effect on consumer demand is expected to be material, especially as households adjust to higher costs against a backdrop of elevated personal debt levels. Compounding the problem is sluggish business investment and flat export growth, which both existed before the recent uncertainty related to US trade policy and further constrain Canada’s economic momentum.
Even as interest rates decline, credit spreads remain near their tightest levels in over a decade, both in Canada and the US. Investment-grade spreads in Canada are at their narrowest in 15 years, reflecting investor confidence in corporate fundamentals and low default risk.
But Briggs cautions that spreads may not be adequately reflecting the true risks in the economy. “Markets are pricing in a Goldilocks scenario – moderate growth, falling inflation, and limited credit stress,” he says. “But we see more risk than the spreads suggest.”
This view has led to a more defensive positioning in fixed income portfolios. Briggs and his team have reduced their exposure to longer-dated corporate bonds and concentrated holdings in shorter maturities. “Short-duration corporate paper offers more flexibility,” he explains. “It allows us to remain nimble and opportunistic if credit spreads widen.”
In addition to reducing credit risk, the firm has increased allocations to government bonds and implemented credit hedges to manage downside risk. “We took advantage of low volatility to add protection when it was cheap,” Briggs says. “Now we’re in a stronger position to weather potential spread widening.”
On top of domestic challenges, Briggs argues that investors may be underestimating the long-term consequences of Trump’s reintroduction of tariffs. “Markets have treated this as political posturing, expecting that it will be walked back,” he says. “But if tariffs are sustained, the hit to Canadian exports could be significant.”
Briggs notes that while tariffs can create short-term inflationary pressure by raising prices, they often lead to lower growth and deflationary risks over time. “If demand drops because prices are too high or [there is] rising unemployment, you don’t get sustained inflation – you eventually get weaker growth and lower prices,” he explains.
A prolonged trade dispute would likely weigh on the Canadian dollar, which has already been under pressure due to the rate differential with the US. Franklin Templeton’s Canadian Fixed Income Team has increased its US-dollar exposure as both a hedge and a tactical position. “The US economy is better equipped to handle a trade war,” Briggs says. “Canada, with its dependence on exports and high household leverage, is more exposed.”
This environment, marked by heightened volatility and uneven growth, reinforces Briggs’ conviction that a broader, more flexible investment approach is needed. “Active management isn’t just about picking the right bonds or timing
interest rate moves,” he says. “It’s about expanding your opportunity set – something that’s hard to do in a traditional core fixed income strategy.”
That’s where Briggs and the team see the benefits of their core plus approach. “If you’re limited to core bonds, you’re essentially competing with passive strategies, and consistent outperformance is tough,” Briggs explains. “Core plus changes the equation.”
The firm’s Canadian Core Plus strategy is available as both a mutual fund and ETF and gives the team freedom to allocate beyond government and investment-grade corporate bonds, tapping into sectors like US syndicated loans and Canadian preferred shares – assets that offer diversification and different risk-return profiles. “These are parts of the market that behave differently,” Briggs says. “Preferreds, for example, throw off income but respond to different factors than bonds. US loans give us access to credit cycles that we don’t have in Canada.”
By broadening the opportunity set, Briggs and his team aim to deliver more attractive risk-adjusted returns – reflected in the strategy’s consistently strong information ratio. “A core plus framework lets us manage risk more effectively and find value where others can’t,” he adds.
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The mortgage wall and the Canadian consumer’s dilemma
The approach for an uncertain market
Published April 8, 2025
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“Markets are pricing in a Goldilocks scenario – moderate growth, falling inflation, and limited credit stress. But we see more risk than the spreads suggest”
Darcy Briggs,
Franklin Templeton
As of December 31, 2024
10%
5%
0%
-5%
-10%
-15%
2019
2020
2021
2022
2023
2024
US GDP
Canadian GDP
2.6%
2.5%
2.4%
2.3%
2.2%
Current
Number of hikes/cuts priced in (RS)
Implied policy rate (LS)
As of March 20, 2025
Implied central bank interest rates – Canada
2.8%
2.7%
0
-0.5
-1
-1.5
-2
-2.5
-3
04/16/2025
06/04/2025
07/30/2025
09/17/2025
10/29/2025
12/10/2025
Rate cuts are coming – but they may not be enough
In response to these pressures, the Bank of Canada has already started cutting interest rates, bringing its overnight rate to 3%. But Briggs and his team believe the central bank will need to go further to support growth and relieve pressure on overleveraged households.
“Our expectation is that the Bank of Canada cuts rates by at least another 100 basis points, bringing the overnight rate to 2%,” Briggs says. “If inflation is running at 2%, you need a policy rate of 2% to get to a neutral real rate.”
Credit spreads remain tight as risks build
Briggs draws a parallel with the US after the 2008 financial crisis, when the Federal Reserve kept real rates negative for an extended period to help households rebuild balance sheets. Given the level of household debt in Canada today, a similar approach may be necessary.
But lower rates won’t automatically resolve all challenges. Briggs expects the Canadian yield curve to steepen, with short-term rates falling faster than long-term yields. “The front end of the curve will come down as the Bank of Canada cuts, but five- and 10-year rates may remain relatively elevated,” he says. “That makes it more difficult for borrowers and complicates decisions for fixed income investors.”
Important Legal Information
This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell, or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice.
The views expressed are those of the investment manager, and the comments, opinions, and analyses are rendered as at publication date and may change without notice. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region, or market.
Commissions, trailing commissions, management fees, brokerage fees, and expenses may be associated with investments in mutual funds and ETFs. Please read the prospectus and fund fact/ETF facts document before investing. Mutual funds and ETFs are not guaranteed. Their values change frequently. Past performance may not be repeated.
Franklin Templeton Canada is a business name used by Franklin Templeton Investments Corp.
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Copyright © 1996-2025 KM Business Information Canada Ltd.