Bond Markets

Short-term outlook is cautious. Longer-term outlook is �neutral�.

Fundamentals (i.e. inflation and economic growth) point to higher yields � more so in the US than in Canada.

Core inflation almost doubled over the past year in the US, while predicted economic growth should be around 3.5%-4.4%. In Canada, inflation remains firm and economic growth is predicted between 2.5%-3.5%.

Expect the Federal Reserve to continue raising rates. Markets still anticipate �easy� credit conditions going forward (because of stronger stock market, a weaker $USD, etc). Do not be surprised if the Fed bumps rates up by 50 bps at some point. The Bank of Canada�s policy on interest rates will be dictated primarily by the $CAD.

Factors Affecting Yields

Asian central bank buying of US Treasuries has tailed off.

Pension funds buying more longer-term bonds (expect this to be a long-term trend).

Globalization � India and China�s inflationary impact on commodities has helped push CRBs to 24 year high.

Structural factors � lower inflation rates, lower inflation risk premiums, low savings rates, and high debt levels in the economy. Corporate savings and investment balance. Emerging markets capital account surpluses are being recycled into the bond market.

General Positioning of Funds

Duration - shorter than index Being selective on lower credit securities. Overweight in mortgage backed securities, asset backed securities, which are generally rated AAA and yielding 50bps more than Government of Canada bonds.

Corporate Bonds

Spreads have compressed as risks have subsided. Default rates are very low. Corporate balance sheets in great shape. Going forward, economy should chug along moderately - which is a great environment for corporate bonds to perform in. However, do not be surprised if there is a slight pullback in the short-term if Treasuries rise further. This would be a buying opportunity. You can anticipate returns of approximately 7.0% over intermediate & long-term.

Income Trusts

Outlook � valuations are slightly ahead of themselves. Cash level has been rising in the MSHIF. A short-term pullback is possible, especially if government bond yields continue to rise. This will create a buying opportunity.

We anticipate returns of 7%-10% for the income trust market this year. Indexation is positive for income trusts. Will provide further liquidity and breadth to the market.

For more information on this forecast, contact John Klotz at johnk@lms.ca or phone (416)-644-7700