The Canadian bond market underperformed the U.S. bond market in April, extending the trend that began in January. As can be seen in the chart below, Canadian yields had fallen versus U.S. ones for a few years reaching, in some cases, record negative spreads at the end of 2015. Since then, however, U.S. yields across all maturities have fallen while most Canadian yields have risen. In large part the changes in 2016 reflected shifting investor expectations regarding the respective central banks. At the end of 2015, the Fed was widely expected to follow up its December rate increase with a number of upward moves in 2016. In contrast, the Bank of Canada was thought to be considering another rate cut to stimulate the Canadian economy. Four months later, both central banks are not expected to make any rate changes for the next several months. As a result, spreads between Canadian and U.S. bonds narrowed sharply.

Canada vs US yield spread

We expect Canadian bonds to remain range bound over the next month. Currently, bond prices are close to the lower bound of their range and we believe they may drift upward during May. In June, approximately $55 billion of coupons and maturities will need to be reinvested, the second highest total in the last ten years. Demand for bonds is likely to exceed new issue supply, leading to modestly higher prices and lower yields. As well, as noted above, Canadian bonds have become relatively more attractive versus U.S. bonds, which may encourage foreign buying at the margin. However, we do not believe that bond prices are likely to hit new highs and, given recent volatility, we are comfortable keeping portfolio durations close to benchmark levels.

The rally in credit spreads over the last two months has erased some but not all of the panic-driven cheapness from the start of the year. Corporate and provincial yield spreads remain attractive, in our opinion. We see the corporate sector as offering the best value currently, so we are maintaining the over-weight allocation and are looking to add selectively. Liquidity remains challenging.

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