The Canadian yield curve steepened in November as 2-year bonds were supported by ongoing Bank of Canada monetary stimulus (in the form of ultra-low interest rates). Yields of 2-year bonds rose only 15 basis points while the yields of longer term maturities rose by more than 30 basis points. 10-year Canada bonds were the worst performing term in the month, as their yields jumped 38 basis points. The shift in Canadian yields was similar to the moves in the United States bond market, although the American shifts were larger. Yields of 2 and 5-year U.S. Treasuries rose 25 and 51 basis points, respectively. 10 and 30-year Treasury yields jumped 52 and 45 basis points, respectively. Interestingly, almost all of these unusually large yield moves in both Canada and the United States occurred within a week of the U.S. election. In the second half of the month, yields were relatively stable.

Canada vs US 10-year Yields

The federal sector returned -1.89% in November, as higher yields pushed bond prices lower. Provincial yield spreads narrowed one basis point on average, but the longer average duration of provincial issues resulted in larger price declines, resulting in an average return of -2.86%. Investment grade corporate bonds fared better than government issues, returning -1.28% in the month. Corporate yield spreads narrowed an average 6 basis points in the month, notwithstanding $10.2 billion of new fixed rate issues. Financial issues (i.e. banks and insurance companies) enjoyed particularly good performance in the period. Non-investment grade issues shrugged at the U.S. election, earning +0.73% in the month. Real Return Bonds declined -2.08% in the month, but that result was considerably better than the -4.86% return of nominal long term federal bonds that have a similar duration. The S&P/TSX Preferred Share index earned -0.65%.

Notwithstanding the rapid bond market reaction to the election of Trump as U.S. president this past month, there remains considerable uncertainty regarding the future of U.S. economic policy. What Trump said on the campaign trail and what he actually proposes once in power may be quite different. As well, it remains to be seen whether Trump, the political outsider, can get Congress to implement his policies. Some observers have suggested that the Republicans in Congress have been trying for years to reduce the budget deficits, so Trump’s plans for larger ones may not have the necessary legislative support. We suspect, however, that Republican intransigence had more to do with opposing Barack Obama’s agenda than fiscal rectitude. Now that Republicans have greater control over where the money is spent, they are likely to become less concerned about the size of the deficit. However, we will have to wait until after the inauguration on January 20th to gain better certainty over the new government’s policy direction. In the intervening weeks, we anticipate heightened volatility due both to the usual reduced liquidity at year end and also to the occasional announcement from the incoming administration catching investors wrong-footed. A 0.25% interest rate hike from the Fed in mid-December is very widely expected and, therefore, should have little market impact.

In contrast with the Fed’s expected tightening move expected in December, the Bank of Canada is unlikely to change its trendsetting rates at its December Fixed Action Date. The Canadian economic data since the Bank’s last meeting has modestly better than expected, and it appears likely that the Bank will wait to see how U.S. developments unfold.

Portfolio durations have been kept close to benchmarks due to potential volatility. That will likely continue unless there is a significant market rally, which we use as an opportunity to modestly lower durations. Corporate bonds remain our preferred sector as yield spreads are historically attractive. The recent steepening of the yield curve between 1 and 5 years has improved the value of 3 to 5 year bonds and we will look to increase the holdings of those maturities while reducing cash positions.