You know you have the right business partner, when they inspire you and act almost as a muse. It’s better still when that partner is also your daughter. This week, Ally hosted her second annual Women’s Health and Wealth Seminar in Peterborough. It was once again extremely well received and attendees left with some important insights from planning to investing. As for the inspiration part of the story, well Ally introduced a certain market theory to the audience that had to do with cosmetics. I’m not going to describe it here, as Ally will be expanding on her talk in next week’s newsletter. For my guest-hosting spot on BNN Bloomberg this Wednesday, I was asked for three stocks on my radar this week. After hearing of Ally’s talk, I just had to pick Ulta Beauty which reported fourth quarter results on Thursday. Stay tuned.

Shifting our focus from our local community to the broader macroeconomic picture, the bond market is currently flashing warning signs that warrant our immediate attention. We are navigating an environment where inflation is proving to be a highly stubborn guest, leaving central bank policy in a delicate balancing act. When you compound this with growing fiscal risks—driven by geopolitical conflicts, supply chain chokepoints, and a noticeable trend of weaker revenues—it becomes abundantly clear that the current landscape demands caution rather than complacency. Given that prevailing rates are lower than they were a year ago, there might be the temptation to go searching for something higher, especially if there is an urge to trim back on equity exposure and proceeds to reinvest.

Navigating the Noise: The Danger of Chasing Yield

In this kind of climate, being highly selective on the fixed-income side isn't just a preference; it’s an absolute necessity. Over the past year, as traditional fixed-income yields fluctuated, we saw a massive migration of capital stretching for yield. The problem is that when you chase yield in a market with compressed spreads, you are inherently taking on hidden risks.

The allure of areas like private credit seemed tempting to many investors seeking returns that were well above inflation. However, the risk-reward calculus in these opaque, often illiquid markets is rapidly shifting, and the margin of safety is evaporating. If you want a tangible indicator of these brewing headwinds, look no further than the recent news of major institutions like JPMorgan quietly writing down loans. We think that this might not be a blip, but potentially a canary in the coal mine. It signals that the borrowers who relied on cheap capital are feeling the squeeze of sustained higher rates. When the largest financial players begin aggressively marking down their loan portfolios, it tells us that the guys who stretched for an extra one percent in yield in private credit might soon be left holding the bag.

And risk isn’t just in the private segment of the market. This past week, Amazon came to market with a US$37 billion public bond issue (spread over 11 segments), making it the fourth largest ever. It also follows a US$15 billion offering back in November and an additional Euro bond issue will take the combined tender to $50 billion. This comes on the heels of roughly a US$32 billion offering from Google-parent Alphabet (which included a 100-year bond). This borrowing is aimed at back-filling the enormous capital expenditures these tech giants have committed to in an effort to build out their AI infrastructure.

Note, Amazon’s deal this week came with a spread over the equivalent US treasury bond yield that was higher than back in November. As the above chart shows, corporate bond spreads have been widening since January and things like a war in the middle east, increased business uncertainty, inflation and potentially deteriorating economic fundamentals don’t exactly scream better credit quality.

The Energy Shock Ripples Outward

To understand why the bond market is shifting, we have to look at the catalysts driving inflation—starting with energy. We need to look past the obvious, immediate pain at the gas pump. Higher oil prices aren't just an energy story; they act as a widespread tax on almost everything. Petroleum is a fundamental input for countless products, from plastics and packaging to synthetic materials, solvents, and asphalt. When crude prices remain elevated for a sustained period, the manufacturing costs for these everyday goods skyrocket, effectively baking higher prices into the core of the economy and ensuring inflation remains sticky. And the longer petroleum prices stay elevated, the more protracted this chain reaction through other products will become.

Chokepoints and Supply Chains: The Strait of Hormuz

The bottleneck in the Strait of Hormuz adds an entirely different, and arguably more dangerous, layer of risk. This critical maritime chokepoint isn't just obstructing the flow of crude oil; it's disrupting the global transit of essential non-energy goods. We are looking at a severe supply-side shock that will ripple through the cost of consumer electronics, agriculture, and manufacturing.

Take fertilisers, for instance. A disruption in shipments severely impacts agricultural yields globally, which will inevitably drive up food prices at the grocery store later this year. The above chart shows the price of Urea (New Orleans in US$ per metric tonne), which is a nitrogen-based fertilizer. Unlike potash, which is mined, urea is manufactured using ammonia and the feedstock for ammonia is natural gas. In addition to crude oil production that has been “shut in” during the Iran war, liquified natural gas (LNG) output has also been shuttered in some countries. This week, urea crossed above US$600/MT. That is still a long way from the highs seen at the start of the Russian invasion of Ukraine, but it is still going to sting.

Similarly, delays in the transport of semiconductors and related technological components mean higher costs for everything from automobiles to basic consumer electronics. This is a recipe for cost-push inflation that central banks cannot easily fix with monetary policy.

The Death of the Rate Cut Narrative

Remember the aggressive rate cuts the market was banking on just a few months ago? They are rapidly evaporating. The initial expectation that the US Federal Reserve would deliver multiple rate cuts this year has been almost entirely priced out of the market. Over in the UK, the Bank of England is now widely expected to actually hike rates this year to combat these renewed inflationary pressures. Here at home, the market has also repriced its expectations for the Bank of Canada. Both the BoC and the Fed hold their policy meetings next week, and the ongoing conflict in Iran, combined with the related supply shocks, could force them to significantly revise their forward guidance. The "pivot" to easy money that so many equity bulls hung to last year has been put on ice, at least for now.

The Fiscal Floodgates in an Election Year

War and geopolitical instability are inherently inflationary, and they are also incredibly expensive. The US deficit is already stretched to historically uncomfortable levels, and increased military spending to support global conflicts is only going to widen that gap further. Crucially, the spending won't stop at defence. We are in a US mid-term election year. As these higher input costs start hammering domestic industries, the political pressure to subsidise affected groups will skyrocket. Expect to see targeted fiscal relief programmes—such as heavy subsidies for farmers in red states who are getting squeezed by fertiliser shortages and soaring fuel costs, or bailouts for manufacturing sectors hit by supply chain delays. More government spending means more government borrowing, flooding the market with new debt issuance just as central banks are stepping back.

The Bear Steepener is Prowling

So, what does this toxic cocktail of sticky inflation, vanishing rate cuts, and massive deficit spending mean for the yield curve? It is the perfect breeding ground for a "bear steepener." To understand the danger here, we have to look at the mechanics. A standard steepening yield curve is often a healthy sign, suggesting economic acceleration ahead. A bear steepener, however, is a different beast entirely. It occurs when short-term rates start to move higher and long-term interest rates rise even more, dragging the whole curve higher. The above chart shows the US Treasury yield curve (from 1-month to 30-year) today, compared with what the curve looked like a year ago.

Right now, the short end of the curve is pinned down (or rather, pinned up) by central banks that are completely paralyzed by sticky inflation. They can't cut rates without risking another inflationary spike. Meanwhile, the long end of the curve is drifting higher because the market sees a tidal wave of government bond issuance coming down the pike to fund massive, unchecked deficits. When you combine stubborn central banks with fiscal dominance, the long end of the yield curve will tend to rise. This dynamic punishes investors holding long-maturity, low-yielding debt, as the price of those bonds drops sharply. Remember the experience of 2022.

It is exactly this scenario which we are positioning for now. As much as we have to be selective on where we want to be in the equity market (geographically and by sector), we have to apply the same discipline to the bond market. By remaining defensive, keeping durations manageable, and avoiding the temptation to stretch for yield in fragile credit markets, we can navigate this bear steepener and have the ability to capitalize on opportunities when they emerge.

On behalf of the Pyle Wealth Advisory team, have a wonderful weekend.     

Andrew Pyle