For much of June, the Canadian bond market followed the lead of other bond markets to higher yields and lower bond prices. Market volatility remained elevated, and for most of the month, economic fundamentals took a backseat to geopolitical headlines, ratings announcements, and new issue supply. The FTSE TMX Canada Universe Bond index returned -0.56% in the month.

The Greek debt crisis dominated global bond markets in June. For much of the month, investors were optimistic that Greece would negotiate a compromise with its three main creditors, the International Monetary Fund, the European Central Bank, and the European Commission. That optimism reduced the flight-to-safety bid for government bonds leading to higher yields. However, when the negotiations faltered, yields fell. This was particularly apparent late in the month, when it became apparent that Greece would fail to repay the IMF as scheduled on June 30th. As can be seen in the chart below, the correlations between European bond yields (as represented by German bunds) and those of Canada and the United States were quite high. While the scales of each of the yield series were different, the movements were very similar. Interestingly, the very low German bund yield actually fluctuated in the widest range of more than 50 basis points, while U.S. Treasuries and Canada Bonds moved in ranges of 40 and 30 basis points, respectively. The sharp drop in Canadian yields late in the month reflected the market reaction to unexpectedly weak GDP data released on June 30th.

Correlations between Canada, U.S. & European Bond Yields June 2015

Canadian economic data in June was, on balance, disappointing. On the positive side, the unemployment rate held steady at 6.8%, as strong job creation offset the impact of an increase in the participation rate (which is also a good thing). However, retail sales and manufacturing sales were both weaker than expected. In addition, the April trade deficit was the second largest on record, trailing only the upwardly revised deficit of March. The hoped for increase in Canadian exports due to the decline in the exchange rate has yet to occur. Perhaps the most negative news in June came at the end of the month when it was revealed that Canadian GDP unexpectedly shrank -0.1% in April, the fourth consecutive monthly decline. It raised the possibility that the Canadian economy would fail to grow in the second quarter, thus falling technically into recession. That, in turn, would increase the potential for another interest rate cut by the Bank of Canada.

In the United States, the economic news during June was generally better than expected and reinforced expectations that that economy was rebounding from its first quarter slowdown. Among the indicators that exceeded their forecasts were retail sales, construction spending, personal income, vehicle sales, and consumer confidence. Even news of the disappointing rise in the unemployment rate from 5.4% to 5.5% was tempered by the fact that the increase was driven by a rise in the participation rate as discouraged workers returned to the labour force. Job creation remained robust. As well, the estimate of the decline in first quarter GDP was revised to -0.2% from -0.7%. The Federal Reserve left rates unchanged, but many observers still expected one or two rate increases before the end of the year.

Internationally, European growth (outside of Greece) was marginally better than expected. However, the incremental improvement was too little to cause any change in the ECB’s quantitative easing. Of greater concern was China’s economy which appeared to be falling short of this year’s 7% growth target. That led to a sharp selloff in Chinese equities, which prompted a rare combination of both interest rate cuts and a reduction in bank reserve ratios. The weaker Chinese growth also appeared to causing weaker commodity prices, which are impacting Canadian producers.

The Canadian yield curve steepened in June as short term yields fell roughly 8 basis points and long term yields rose 7 to 10 basis points. The decline in 2 and 5-year yields was caused by the weak GDP data at the end of the month that raised the possibility of another Bank of Canada rate cut this year. Longer term yields moved higher in sympathy with rising yields in other global bond markets, although the Canadian move was muted by the GDP data. In the United States, the yield curve also steepened as 2-year yields rose 6 basis points and 30-year yields climbed 26 basis points. In Germany, the curve steepening was more severe as 2-year yields were little changed but 30-year yields jumped 46 basis points. (That outsized increase in yields resulted in the prices of 30-year bunds falling over 10% in the month!)

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