The Canadian bond market extended its four month decline as it fell sharply in early September, but rallied back over the balance of the month to finish with modest gains. The initial selloff reflected improving economic developments, as well as the easing of geopolitical tensions regarding Syria. The late-August rally was completely reversed and by mid-September long term Canada Bond yields rose to their highest levels in two years.  The subsequent rebound in bond prices and decline in bond yields was spurred by the U.S. Federal Reserve’s decision not to taper its bond purchases. The DEX Universe gained 0.52% in the month.

Canadian economic news, as noted above, was generally positive during September. Unemployment fell to 7.1% from 7.2%, as a result of robust job creation with 59,200 new positions created in August. As well, the Canadian economy rebounded from weakness in June brought on by the Quebec construction strike and the flooding in Alberta. July data, including GDP, factory sales, and retail sales, showed that the Canadian economy had resumed its slow and steady growth despite the temporary headwinds. Even housing starts, long forecast by housing bears to be at risk of plummeting, remained at satisfactory levels. Inflation remained dormant, with no change in prices on a monthly basis and a decline in the annual rate from 1.3% to 1.1%. The Bank of Canada, however, lowered its forecast of growth for the balance of the year, as net exports and business investment have been disappointing.

In the United States, the unemployment rate declined to 7.3% from 7.4%, although job growth was disappointing due to downward revisions to the previous two months’ estimates. Other labour market indicators were less ambiguous, however; initial claims for unemployment benefits, for example, fell to pre-crisis levels. Vehicle sales also returned to pre-crisis levels, hitting their highest pace in almost six years. As well, manufacturing surveys showed greater than expected strength. Less positively, consumer confidence declined somewhat and retail sales were weaker than expected.

The key event for global bond markets in September, though, was the Fed’s decision to not taper its purchases of U.S. Treasuries and mortgage-backed securities. For the last four months, Fed speakers had talked about reducing its quantitative easing programme and the markets’ consensus had anticipated that the reductions would begin in September. Bond prices rose as investors revised their expectations for the timing of Fed tapering, including the possibility that cutbacks to the bond purchase programme will not begin before early 2014.

Another factor that boosted bond prices in late September was the re-emergence of the U.S. political deadlock. The Republican-controlled House of Representatives and the Democratic-controlled Senate could not agree on a budget resolution that would permit the government to keep operating past September 30th. Without the resolution, non-essential federal government services would be curtailed and approximately 800,000 out of a total 2.2 million federal workers would be furloughed. If the government shutdown did not end quickly, it could lower growth by as much as 1.4% in the fourth quarter. Of even greater concern was the debt ceiling: unless it was increased by roughly October 17th, the federal government could technically default on its debt. Unfortunately, there were no indications that the Republicans and Democrats were willing to compromise by month end, and that prompted a flight to safety bid for bonds, both in the United States and in Canada.

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