The Canadian bond market enjoyed modest returns in July, with the DEX Universe Bond index earning 0.66%. In general, bonds continued to benefit from investors seeking safe assets in turbulent times. Economic data was mixed, but often was below expectations, raising concerns about a double dip recession. However, developments in the European debt crisis remained the dominant factor in the market moves.

In Europe, much of the attention was on Spain. In that country, the unemployment rate hit 24.6%, property values continued to fall, and a number of regional governments sought financial support from the federal government. Yields of Spanish bonds rose sharply as investors became increasingly concerned about the Spanish government’s ability to service its debt as it struggled with supporting both the regional governments and its troubled banking sector. The yield on 10-year Spanish bonds started the month at 6.25% but rose to over 7.60% as investors demanded higher returns to accept Spanish risk. On July 26th, though, the president of the European Central Bank, Mario Draghi, stated the bank “would do whatever it takes to save the Euro.” That comment was widely interpreted to mean that the ECB would begin buying Spanish bonds to reduce their yield and make it easier for Spain to finance itself. Spanish yields dropped, as did those of other higher yielding European countries such as Italy. The 10-year Spanish bond yield fell to 6.71% by month end. In contrast, the yields of “safe havens” such as U.S. Treasuries and Canada bonds, which hit record lows in mid-July, rose following Draghi’s statement.

Canadian economic data continued to show moderate growth with little inflationary pressure. GDP increased 2.4% over the last twelve months: a positive result, but not fast enough to eliminate much of the slack in the economy remaining since the recession. Job creation was slower than expected, but the unemployment rate edged down to 7.2% from 7.3% as the participation rate eased slightly. Housing starts were stronger than forecast, perhaps due to buyers trying to beat the new, more restrictive mortgage regulations that were to take affect this month. The Bank of Canada left its trend setting overnight interest rate unchanged at 1.00%, as it acknowledged that global economic growth was slower than anticipated. In light of ongoing economic woes in Europe, as well as decelerating growth in China and the United States, it now seems unlikely that the Bank of Canada will raise rates this year.

In the United States, most of the economic data received in July was weaker than forecast, which led many observers to anticipate even slower growth over the balance of 2012. Surveys of consumers and businesses showed both groups becoming more cautious in their outlook due to slower global growth, the ongoing European debt crisis, and the potential fiscal cliff looming in the United States. Consumers also reacted to a less robust labour market, cutting back on retail sales and increasing their savings. Less confident about future growth, businesses chose to defer investment spending. The generally weaker data in the month was supportive of bond prices, and some market participants began anticipating that the U.S. Federal Reserve would soon announce another round of monetary stimulus.

We recall that the Canadian bond market surged higher in May, with the DEX Universe Bond index gaining more than 2% in the month. At the time, we noted reports of significant foreign buying of Canadian bonds as global investors sought a safe haven from the European debt crisis. In July, Statistics Canada revealed that foreign bond purchases during May, in fact, set an all-time record for a single month of $16.7 billion. This extended the buying trend that began in February, and which appears to have continued since May. Without this foreign interest, Canadian bond prices would have been markedly lower and yields higher.
Foreign Purchases of Canadian Bonds

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