Most investors are aware of recent moves by the Bank of Canada to begin buying corporate and provincial municipal bonds in a big way, including junk bonds. Bank of Canada is also making massive purchases of Canada Mortgage Bonds (CMB).
What many investors may not be as aware of is what may be a next for Canada’s central banks, if things get really bad - yield curve control. I'll explain what this is and why it matters for the average investor.
Yield curve control is something which has not happened since World War II. However, it's entirely possible in this current environment, given how low government bond yields have gone of late. The idea is to keep the short end of the yield curve below the longer end of the curve to avoid inversion and keep net interest margins positive for banks.
The government has much greater ability to influence the short end of the curve through massive bond buying, which is why emphasis is placed on pegging short term bonds at some level, to maintain a specific curve and promote longer-term lending, like mortgages, that may otherwise become unattractive in an inverted yield curve scenario.
The biggest risk for bonds right now, in my view, is rock-bottom interest rates alongside widespread unemployment and slowing economic activity. If banks do not believe they can generate enough of a return on the money they lend out, the risk is that lending will slow, furthering the decline of economic activity in a downward-spiral like fashion.
Invest wisely, my friends.
