The Canadian bond market experienced a quietly volatile, seesaw month in July.  Bond prices continued their post-Brexit rally in the first week, hitting their highest levels of the month. Concerns about the British referendum subsequently faded, with growing expectations that Britain would delay triggering its departure decision until next year, as well as the realization that the impact was going to be relatively minor everywhere except in the U.K. As a result, over the next few weeks, bonds gave up most or all of their earlier gains. Only a strong rally late in the month resulted in noticeable gains for the period. The swings in bond prices through July were significant, as can be seen in the chart below. The FTSE TMX Canada Universe Bond index returned 0.84% in the month.

During July, Canadian data continued to show that our economy was struggling to grow. While somewhat dated, we finally received economic data that indicated the impact of the Alberta wildfires in May. In that month, Canadian GDP shrank 0.6%, but excluding the oil sands the economy declined only 0.1%. (Other significant areas of weakness were oil refineries and less demand for utilities due to weather.) The unemployment rate declined to 6.8% from 6.9% a month earlier, but the “improvement” came as a result of a sharp drop in the participation rate rather than job creation. Revisions to trade data showed worse deficits than previously thought, with each of the last three months recording deficits larger than $3 billion. In the most recent month, May, there was also surprisingly negative news that non-energy exports fell 1.8% while energy exports actually climbed 7.1% as higher oil prices offset lower volumes. Not all of the economic news was negative, however, as housing starts and retail sales both exceeded expectations, and inflation held steady at +1.5%. The Bank of Canada left rates unchanged, but its accompanying statement was less dovish than many observers expected and that reduced expectations of a possible rate reduction later this year. That put some upward pressure on shorter term bond yields.

July 16 Bonds Volatility

U.S. economic data received during July was mixed but, on balance, it indicated continued growth at a moderate pace. While construction spending was below expectations and the trade deficit widened, the labour market showed improvement; claims for unemployment benefits fell to 40-year lows, job creation was robust and the participation rate increased. In addition, retail sales were stronger than expected and there were signs that business investment was finally improving after several months of weakness. Inflation held steady at +1.0%, although core prices rose at a 2.3% pace. The Federal Reserve left monetary policy unchanged in July. The Fed’s announcement was less dovish than expected, but largely ignored. Late in the month, shortly after the Fed decision on interest rates, growth in U.S. GDP during the second quarter was estimated to have been only 1.2%, which was significantly slower than forecast. Although much of the shortfall was due to an unexpected but temporary drop in inventories, the weaker growth pace contributed to a bond market rally into the end of the month.

The price of oil plunged almost 14% in July on concerns that the market was oversupplied. From its peak in June of over $50 per barrel, oil seemed headed for a test of $40 per barrel. The Canadian exchange rate, which historically has been 80% correlated to oil prices, did not follow in this instance. The value of the Loonie fell less than 1% on the month. International demand for Canadian bonds probably played a part in keeping the exchange rate steady.

CAD/USD vs WTI Oil

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