In the second quarter of 2026, economic headlines in North America were dominated by a shifting interest rate narrative, as central banks moved away from an expected easing cycle toward a more cautious, “higher for longer” stance. Both the Federal Reserve and the Bank of Canada held policy rates steady—at 3.75% in the U.S. and 2.25% in Canada—signalling that inflation remained above target and that further progress was needed. At the same time, updated forward guidance and economic projections pointed to a slightly higher path for interest rates through year-end, reflecting concern that inflation would prove more persistent than previously expected. In fact, the next interest rate moves are trending in the direction of hikes, not cuts. The futures market is expecting one hike from the Federal Reserve by year end and one hike from the Bank of Canada, but not until 2027. Notably, Kevin Warsh has now transitioned into Chair of the U.S. Federal Reserve, and chaired his first Fed meeting in June, followed by his first press conference. His comments were more hawkish than the market was anticipating. Hawkish, meaning he favors rates moving higher not lower.
Central bank caution was driven in large part by inflation dynamics. While core inflation showed signs of stabilising, headline inflation is rising, driven by rising global energy prices. Rising energy costs are directly linked to the supply disruption caused while the Strait of Hormuz remained closed. Since the beginning of the conflict, north American gas prices rose 38%, therein lies the inflation story. Central banks acknowledged that these energy-driven pressures could delay the return to their 2% inflation targets and risk becoming more entrenched if left unchecked.
The silver lining to this story is that U.S. – Iran negotiations are, allegedly, making progress and ship traffic will begin flowing through the Strait. We’ve read these headlines before; none the less energy prices have moved significantly lower with WTI and Brent crude trading closer to $70 a barrel; 35% below their recent highs. This bodes well for relief from higher gas prices, and in due time, headline inflation.
Meanwhile, economic data releases painted a mixed picture. Growth remained positive but modest, with forecasts for both the U.S. and Canada revised slightly lower, suggesting a slower expansion than anticipated earlier in the year. Labour markets continued to show resilience, with unemployment remaining relatively stable.
Against this backdrop, the Diversified Income Fund delivered a return of 0.2% for the quarter. April and May were constructive, with returns of 0.6% and 1.8%, respectively, before June declined by 2.1% as markets adjusted to this new reality.
Amid the market volatility, it’s important to step back and consider the role Matco’s Diversified Income strategy is designed to play. The fund generates a yield of 4.4%, offering a meaningful premium relative to money market and GIC alternatives. For investors seeking stable income with a focus on capital preservation, that income stream remains a key component of long-term returns.
Throughout the quarter, we were active in positioning the portfolio to reflect the fund’s strategy within the current environment.
First and foremost, we reduced the interest rate sensitivity of fund. For the more sophisticated investor, we reduced the fund’s duration, with a current position of 6.45 years. This duration is 0.60 years shorter than the Canadian bond index. This reflects our view that although short- and medium-term rates have likely reached a point of equilibrium, the risk-reward of investing in longer term interest rates simply isn’t compelling. The thesis behind our view is that inflation will linger above the central banks desired band 2% target. In addition, bond investors aren’t loving the elevated and ever-increasing government debt levels. By contrast, we think the 5–10-year part of the interest rate curve offers great value, particularly in selective corporate bond positions.
This segues us nicely to our next portfolio adjustment. During the quarter, we added two new corporate bond lines to the portfolio. Namely, we added a Fairfax financial 10-year bond at a 4.4% yield, and a TC Energy 10-year bond at a 4.53% yield. Fairfax Financial is a Toronto‑based financial holding company primarily centred on property & casualty insurance and reinsurance, alongside a large, value‑driven investment portfolio. TC Energy is a Calgary‑based energy infrastructure company that builds and operates pipelines and related assets across North America. Both positions reflect attractive yields within our 4% to 5% portfolio yield target.
For those who have been following along, we continue to add gradually to our Canadian dividend equity income sleeve within the portfolio. This past quarter, we initiated a position in Peyto Exploration. Peyto Exploration & Development Corp. is a Calgary‑based Canadian energy company focused on the exploration, development, and production of natural gas, primarily in Alberta’s Deep Basin.
As of June 30th, the diversified income fund’s investment mix is represented by:
- A 38% allocation to corporate bonds
- 24% in federal bonds
- 24% provincial bonds
- 10% mortgage investments and
- 2% dividend paying equities
- 2% Cash
The broader outlook for income-oriented investments has become more complex.
Although the market is anticipating rate hikes, our assessment of fundamental data suggests easier monetary policy is needed. North American labor markets are seeing slower growth in jobs, consumer activity has been resilient but cooling gradually, housing markets would be better supported by lower interest rates, and GDP growth overall is trending sideways to lower. However, given the battle of inflation driven by rising energy prices, central banks are unlikely to cut prematurely and tempt inflation to reignite.
In this environment, the traditional playbook of pairing stocks with bonds for diversification has become less bullet-proof. Over the past several years, those asset classes have moved more in tandem, reducing the effectiveness of a purely balanced approach. As a result, income portfolios need to be constructed more deliberately. That means expanding beyond traditional bonds to incorporate a broader set of income-generating assets, including corporate credit, mortgages, and dividend-paying equities. That’s how our portfolio is positioned today, with a focus on preserving capital, generating reliable income, and proper diversification to navigate uncertainty while compounding returns over time.
