The persistent echo of inflation, once dismissed as a fleeting phenomenon, is now fundamentally reshaping the landscape of Canadian fixed income, presenting investors with a recalibrated opportunity for returns. Derek Johnson, Vice President and Portfolio Manager at Canoe Financial, argues that the era of structurally higher inflation has ushered in a "new, or old," returns profile for Canadian fixed income assets, moving away from the ultra-low yields that characterized the pre-2022 environment. This shift, driven by a confluence of global geopolitical events, domestic economic pressures, and demographic trends, positions Canadian fixed income, particularly high-quality corporate bonds, as a compelling allocation for investors seeking both income and capital preservation.
The term "transitory inflation" has become a relic of a bygone economic narrative, largely due to the jarring experiences of 2022, which left the investment world grappling with the enduring nature of price increases. While the immediate shockwaves from the US-Israeli conflict and its subsequent impact on oil prices have somewhat subsided, the broader reality has been reinforced: inflation is likely to remain elevated for an extended period. This enduring inflationary environment has necessitated a significant repricing of assets, particularly within the fixed income markets.
"Prior to 2022, that great repricing, we lived in a world where risk-free rates were very low, credit spreads were very high. In that world, you wanted to invest in corporate bonds and not in government bonds," Johnson explained. This sentiment reflects a common investment strategy during periods of low interest rates, where investors sought higher yields by taking on more credit risk. The prevailing wisdom was that the perceived safety of government bonds offered little compensation for their low yields, making corporate debt a more attractive proposition.
However, the economic landscape has dramatically transformed. "Fast forward to today, we have the exact opposite," Johnson observed. "We have high risk-free rates and very tight credit spreads." This inversion means that government bonds, which represent the benchmark risk-free rate, now offer significantly higher yields than in previous years. Simultaneously, the premium investors demand for taking on credit risk in corporate bonds has compressed, meaning the difference in yield between a government bond and a corporate bond of similar maturity is smaller.
This recalibration in risk and reward dynamics has led Johnson to advocate for a strategic shift in fixed income allocation. "When I think of risk-reward, that leads us to own high-quality corporate bonds. Things that are basically government, like infrastructure and banks," he stated. The focus is now on "no high yield," but rather on securing the risk-free rate plus a modest credit spread premium. This approach prioritizes the stability and predictable income streams offered by these highly-rated corporate issuers, which often operate with characteristics akin to government entities, such as strong regulatory oversight and essential service provision.
The Macroeconomic Crucible: Inflationary Pressures and Growth Concerns
Canada, while experiencing a more rapid slowdown in inflation compared to the United States, has not been immune to the global macroeconomic forces fueling price pressures. The oil shock emanating from geopolitical tensions, coupled with the burgeoning demand for components in the AI infrastructure buildout, has contributed to elevated prices for specific goods and technical components. Underpinning these immediate factors is a broader global trend towards reshoring, building redundancy in supply chains, and renewing domestic manufacturing capabilities. These strategic shifts, while potentially enhancing long-term economic resilience, are inherently inflationary in the short to medium term, as they can lead to increased production costs and reduced global supply efficiencies.
Simultaneously, Canada faces headwinds to its economic growth. The nation experienced a technical recession in the fourth quarter of 2025 and the first quarter of 2026, a period characterized by contracting economic output. Despite this slowdown, Johnson notes that the Bank of Canada (BoC) has maintained a level of accommodative monetary policy, which, while intended to support the economy, also tempers the likelihood of a prolonged and severe recession. Furthermore, significant government spending initiatives, particularly in infrastructure and defense, under Prime Minister Carney’s administration, are expected to be accretive to both economic growth and inflation.
However, underlying demographic shifts present a more profound and persistent challenge to Canada’s GDP growth. Johnson highlights the aging population as a critical factor, a trend exacerbated by recent curbs to immigration. As the baby boomer generation moves into retirement, they transition from being economically active contributors to a growing economically unproductive consumer class. This demographic shift creates a "stagflationary cohort," characterized by consumption without commensurate production, which can exert downward pressure on economic growth while simultaneously contributing to inflationary pressures through sustained demand. Johnson draws a parallel with Japan’s economic trajectory, suggesting that without significant policy interventions, particularly in immigration, Canada risks following a similar path of prolonged stagnation and demographic imbalance.
In light of these competing economic forces – persistent supply-side inflationary pressures and moderating demand due to demographic trends and slowing growth – Johnson anticipates the Bank of Canada will maintain its current interest rate policy. "The Bank of Canada will hold rates steady on Wednesday during its scheduled interest rate decision," he predicts. His reasoning is that the primary drivers of inflation in Canada are rooted in supply-side constraints, such as global supply chain disruptions and commodity price volatility. In such a scenario, further tightening of monetary policy through interest rate hikes, which primarily targets demand, would have limited efficacy in controlling these supply-driven price increases and could disproportionately harm economic growth.
Navigating Canadian Fixed Income: A Strategic Allocation for Advisors
Despite the complex interplay of macroeconomic forces influencing central bank decisions, the current environment has rendered the Canadian fixed income market a fertile ground for generating strong total returns, provided investments are strategically positioned. Johnson points to the performance of Canoe Financial’s own Canadian Bond Advantage Fund as an illustrative example. Since yields peaked in October 2023, the fund has delivered annualized returns of just over seven percent. This level of return, approaching historical averages for equity markets but with the comparatively lower risk profile of fixed income, makes a well-allocated fixed income portfolio a prudent choice for many investors.
Achieving these robust returns necessitates venturing beyond traditional government bonds and into the Canadian corporate credit space. Canoe Financial, according to Johnson, typically focuses on issuers rated from triple-A down to high triple-B. This segment of the corporate credit market is characterized by a high degree of quality and stability, with Canadian banks representing a particularly attractive allocation due to their strong regulatory frameworks and systemic importance.
The strategy employed by Canoe Financial involves a combination of these high-quality corporate bonds with an average duration of approximately seven years. This duration profile is designed to offer a degree of protection against deflationary shocks while simultaneously generating sufficient coupon income and carry to offset the impact of higher inflation. Johnson acknowledges that these types of fixed income allocations are often perceived as "unsexy" due to their lack of speculative appeal. However, he argues that this inherent conservatism is precisely their strength in the current economic climate. The focus is not on chasing aggressive growth but on securing solid, reliable returns through a less volatile asset class.
The fundamental principles of owning a core bond fund, as articulated by Johnson, remain paramount: income, insurance, and liquidity. "We always pitch three fundamental principles of owning a core bond fund. You want income, you want insurance, and you want liquidity," he stated. The income component is now more attractive than it has been in years, offering a steady stream of cash flow. The "insurance" aspect refers to the role fixed income plays as a diversifier and a hedge against equity market downturns. In periods of significant market volatility, when stocks can decline sharply, a liquid bond portfolio provides a stable asset that can be sold to reallocate capital to more opportunistic investments.
"When stocks do go down 30% and you want to reallocate, you want something liquid to sell, and that’s your bond portfolio," Johnson emphasized. He urges advisors to consistently remind themselves and their clients of the intrinsic value of lower-yielding, lower risk-reward assets. "Advisors need to remind themselves and clients that there’s a reason why you own lower yielding or lower risk-reward, lower volume assets. It’s not for the return expectations. It’s for the safety, the insurance, the liquidity, and the income." This perspective underscores the enduring importance of fixed income as a foundational element of a well-diversified investment portfolio, offering stability and predictable returns in an increasingly uncertain economic environment. The current inflationary backdrop, while presenting challenges, has paradoxically revitalized the appeal of fixed income by offering more attractive yields and a clearer path to generating meaningful total returns.
