Our base case is that, for most of the rest of the year, U.S. 10-year yields will remain in the 1.5%-to-2% range. And odds of breaking above 2% and below 1.5% are pretty even.

Let me explain. Bond investors remain concerned mostly about the rising inflation, and there is an ongoing battle between those who, like the Fed, believe that the inflation pressures are transitory and those that believe that we are at the cusp of a multiyear increase in inflation, the end of deflationary fears.

Call it the battle between Team Transitory and Team Structural. The transitory argument is often reduced to just base-case argument, simply saying that inflation increase will follow mathematically because of a drop in energy and inflation last spring when COVID hit the world.

But there is more to the transitory argument than just base effect. It includes also concerns about supply bottlenecks during COVID. Think about the lumber prices going up more than 500%; shortage of bicycles, treadmills, tents, outdoor space heaters; stories about automakers facing chip shortages; housing prices translating into higher shelter costs; rising rates on shipping containers.

Finally, Team Transitory is pointing out to the pent-up demand for travel, accumulated savings, and these expectations that once the country’s open, everybody will spend a ton of money on travel.

Now, Team Strategic takes all these short-term drivers of inflation and extrapolates them into the future. The narrative is basically following “if it’s not one thing, it’s another”; if it’s not bicycles, it will be snowshoes. And a series of transitory inflation drivers will lead to higher inflation expectations.

Then you add to it super-loose fiscal policy, ballooning deficits, central bankers that haven’t seen inflation in their careers and are eager to see higher inflation; carbon tax introduction; reshoring. The list goes on. And rising wages are almost always part of the discussion.

Our view is that the supply bottlenecks will dissipate as economies reopen for the rest of the year. China’s credit tightening will weigh on commodity prices, in particular iron ore and copper. Chip shortages will get resolved. We have recently seen opening of five GM plants which had been closed because of semiconductor shortages.

Looking at the reopening experience in Australia, we see significant a spike in labour force participation, mainly women. If we look at experience of Israel, there is no evidence of erupting pent-up demand on opening. Lack of wage pressure in Asian countries. Higher share of online retail sales.

We are more comfortable with these being transitory arguments. Now, as demand for goods eases and demand for services comes into force, the inflation expectations will simply get rebalanced, and will likely pass, and we will again face these long-term deflationary structural pressures. They were deflationary before COVID, and they will be even more deflationary after.

Before COVID, we knew about demographics, older citizens spending less on consumption, saving more. We knew about technology leading to productivity, improvements which offset increases in labour costs.

After COVID, we know an increase in potential labour force because more people can now sell their time without leaving home. That brings into the labour force more women, more people with disabilities, people living in areas with lower costs of living, people only able to work part-time. It extends working life of people who are on the cusp of retirement, as they can take a slower time extracting themselves from the labour force.

In addition, to slow the population growth because of COVID deaths and fewer births. So we are also going to see, most likely, an increase in precautionary savings because of the COVID experience. All of these are likely to bring inflation pressures down. So with no lasting change to inflation, only once the labour force recovers, which is the main objective of the Fed, central banks will start hiking rates. But this is a long way off.

To conclude, the time to buy inflation protection was last year. We believe that much of the inflation fear and peak of growth expectations is already in the bond price, whether we are looking at the yield curve steepness, risk premium run-up, which has been almost as high as during the taper tantrum in 2013, which was a complete surprise. Not now.

Inflation breakeven’s up above pre-COVID levels. So the lasting return of inflation and much higher yields are not our expectation. It’s a tail risk of even a base case for us. Yields can spike on botched Fed implementation, sort of crisis confidence, but that would be temporary. They can also drop below 1.50% on disappointing data vis-à-vis elevated expectations.

Our base case is, for the rest of the year, 10-year yields will trade in the range, most likely, for most of the time, between 1.5% and 2%. And odds of a break above 2% and below 1.50% are pretty even, and we can take advantage of those spikes above and below to trade duration tactically.

Well, it’s been a tale of two quarters for the FX markets this year. In the first quarter, we saw the dollar rally quite strongly and quite broadly against a number of currencies on the back of better vaccination success in the U.S. than abroad, and stronger U.S. economic data as well.

In the second quarter, however, we’ve seen the dollar give back pretty much all of those gains, and it now trades at cyclical lows against the euro, the British pound, and the Canadian dollar. Now importantly, it’s not that the U.S. economy has faltered that has the dollar declining. But instead, there’s a variety of long-term fundamental factors that are still weighing on the greenback. These are things like fiscal and trade deficits, the U.S. dollar’s overvaluation, and the changing composition of the world’s massive global foreign exchange reserves, which amount to US$12 trillion, where we see gradually a shift of capital away from the U.S. and toward other regions.

So, the U.S. dollar is now in the second year of its multiyear decline, its multiyear U.S.-dollar bear market, and we think that that downward trend will continue over the next couple of years, with the currency weakening by another 10% to 20% over that period.

The currencies that should benefit most in that environment are cyclical ones, so currencies that have exposure to commodities; that are most tightly linked to the global economic reopening. So as you’d expect, we’ve got emerging-market currencies that fall into that bucket. We have other currencies like the Canadian dollar, the Australian dollar, and the Norwegian krone as well.

Now the Canadian dollar in particular has benefitted quite a lot over the past year. It’s now this year’s best-performing developed-market currency. And we’d like to say that there’s a lot to love about the loonie, even here. It’s not just about commodities. Most people think of oil, but there’s a variety of other commodities that are also positive for the loonie—lumber, we’ve got a variety of other agricultural, energy, and metals commodities that have all seen their prices rise and quite substantially.

The Canadian economy benefits from the fiscal spending that we see in the U.S. and in Canada. The country has low net debt, immigration should rebound once borders reopen, and we’re seeing the vaccination effort is well underway. So all of these things have the Bank of Canada getting a little bit more optimistic about revising upward their growth forecasts. And to the extent that markets are pricing in a quicker normalization of interest rates in Canada than abroad, that also offers a bit of a yield boost to the Canadian dollar.

So we’ve changed our forecast this quarter, expecting to see continued strength in the loonie. Our new forecast is for the U.S. dollar/CAD exchange rate to trade at 1.15 per dollar over the next 12 months.