The federal bond sector returned -0.16% in the month, as shorter term bond gains were insufficient to offset the losses on longer term issues. The provincial sector returned -1.01% as the longer average durations of those bonds resulted in greater declines in prices as yields rose. As well, provincial bonds were hurt by their yield spreads widening an average 5 basis points because of international selling, some poorly received new issues, and investors becoming slightly more risk averse. The corporate sector earned -0.51% in June as yield spreads moved an average 9 basis points wider. The increases in corporate yield spreads were due, in part, to a risk-off attitude by investors, as well as robust new issuance. In addition, a reduction in Enbridge’s credit rating resulted in significant widening of spreads for BBB-rated issues. Enbridge Inc. finally announced details of its re-organization that will shift operating assets from the parent company to Enbridge Income Fund, and Standard & Poors quickly cut the Enbridge ratings from A to the BBB category. DBRS reacted more slowly, placing Enbridge on negative watch for lower ratings. Although the downgrades had been largely anticipated, the actual announcements led to some additional widening in Enbridge’s yield spread spreads. Other BBB-rated issuers also experienced wider spreads as a result of the Enbridge move, because some investors did not want their overall BBB exposure to increase and they chose to sell other issues rather than Enbridge bonds. The large amount of Enbridge-related bonds outstanding meant that the BBB weighting in the FTSE TMX Canada Universe increased by a remarkable 1.1% to 10.0% in the month. Over the last seven years, the weighting of BBB-rated issues in the benchmark FTSE TMX Canada Universe has doubled from 5% to 10%, and clients should review their Investment Policy Statements to determine if their existing investment constraints remain appropriate or they need to be revised. New issuance of corporate bonds was $12.4 billion, a record for the month of June. So far in 2015, new issues are 15% higher than last year’s pace. Large new issues included $1.75 billion of 5-year deposit notes from the Bank of Nova Scotia, $1.5 billion of NVCC subordinated debt from TD Bank, and Kraft Canada raised $1.0 billion in three tranches as part of a multi-currency financing. Non-investment grade corporate bonds earned 0.52%. Real Return Bonds returned -0.76%, thereby outperforming nominal long term federal bonds that earned -1.35%. A slightly stronger than expected CPI release in the month prompted more interest in RRB’s.

While many observers believe the Fed may finally start raising rates at its September meeting, we think the U.S. central bank will not move until at least December. The low unemployment rate in the United States has not translated into robust consumption and stronger growth; it seems the recovery has been relatively narrow, with the average American not experiencing improvement in average income or wealth. We believe the Fed is waiting to see a broadening of the economic recovery before it commences a tightening of monetary policy. As well, the impact of lower oil prices and the strength of the U.S. dollar are likely to keep the U.S. growth rate muted, allowing the Fed to be very patient before acting.

The continued weakness in Canadian growth is in contrast with the Bank of Canada’s optimistic forecast that the impact of weaker energy prices would be “front-end loaded” with growth rebounding after the first quarter. While another interest rate reduction would do little to directly offset weaker oil and metal prices, we cannot totally discount the possibility that the Bank of Canada will cut rates again. For that reason and the uncertainty surrounding the Greek debt negotiations, we are keeping durations only slightly shorter than benchmarks.

We expect the recent widening of corporate spreads in reaction to the Enbridge downgrades to unwind over the next few months. Corporate creditworthiness outside of Enbridge has not deteriorated and the recent widening in spreads has simply made those issues more attractive. We continue to over-weight the corporate sector.

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