The Canadian bond market experienced a sharp decline in prices and rise in yields in the first half of September, but a rally in the second half of the month erased roughly half of the losses. In large part, the swings in the Canadian bond market closely followed those in the U.S. market. The early weakness appeared to be due to concerns that faster than expected U.S. economic growth would lead to earlier tightening of monetary policy by the U.S. Federal Reserve. However, weak global growth data in the second half of the month, combined with falling equity markets, caused bonds to rebound. The FTSE TMX Canada Universe Bond index returned -0.63% in the month.

Canadian economic data remained in its Goldilocks mode: not too hot and not too cold. Unemployment held steady at 7.0%, with job creation continuing to alternate on a monthly basis between losses and gains. In the most recent month 11,000 jobs disappeared, but that followed 41,700 new jobs the previous month. (The volatility of labour statistics in recent months is diminishing their credibility and this was reinforced by details that indicated private sector employment fell a record, and not entirely believable, 111,800 positions in the most recent month.) The Canadian trade balance continued to improve from the deficits of the last two years, registering the highest monthly surplus in almost six years. Manufacturing sales were also robust. However, retail sales were weaker than anticipated and Canadian GDP unexpectedly failed to grow in the most recent month as oil and gas production was weaker than forecasts and utility demand was reduced by cool weather. Canadian inflation held steady at 2.1%, but the core rate jumped from 1.7% to 2.1%. The Bank of Canada has stated in the past that it considers the core rate a better indicator of underlying inflationary pressure, and the increase above 2% challenges the Bank’s contention that inflation is not accelerating.

U.S. economic data, particularly in the first half of the month, were fairly positive. Unemployment fell to 6.1% from 6.2%, albeit with mildly disappointing job creation, but business surveys, construction spending and new vehicle sales were all stronger than expected. In addition, consumer credit growth was quite strong. Later in the period, industrial production unexpectedly fell and housing starts were less than expected. The U.S. Federal Reserve again reduced its monthly bond purchases, and is widely expected to terminate its quantitative easing programme at its next meeting on October 29th. An upward revision to the estimated pace of U.S. GDP growth in the second quarter to 4.6% from 4.2% was largely ignored by the market even though much of the increase was due to higher business investment which bodes well for future growth. Late in the month, news that the portfolio manager of the world’s largest bond mutual fund, Bill Gross, was changing employers caused some volatility in the bond market as investors anticipated that his old company, PIMCO, would lose clients and need to sell bonds to cover redemptions.

Globally, the Eurozone economy remained moribund. Of particular concern was European inflation that edged lower to 0.3%, worryingly close to deflation. In Japan, its second quarter GDP shrank on sharply lower consumer and business spending, and industrial production in the most recent month had a surprising decline. In China, economic growth was largely as anticipated, but pro-democracy protests in Hong Kong late in the month introduced yet another source of geopolitical uncertainty to the markets.

The Canadian dollar weakened 2.9% versus the U.S. dollar in September. However, the Loonie was not alone in falling against the greenback; the British pound declined 2.3%, the Euro dropped 3.8%, and the Japanese Yen fell 5.1%. Only the Chinese Renminbi was able to hold its value against the U.S. currency in September. As the United States is Canada’s largest trading partner, the decline in our exchange rate, if it holds, should be beneficial to Canadian exporters. That would likely please the Bank of Canada, which has been looking for increased economic activity from trade, as well as from business investment. The Bank has indicated that it wants to see those two areas improve before it would consider reducing its extraordinary monetary stimulus. The weaker exchange rate will have a second, less positive effect. It will result in higher import prices and thus put upward pressure on inflation. This will take some months to occur, but it will increase the pressure on the Bank of Canada to eventually raise interest rates.

The Canadian Exchange Rate Weakens in September

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