Contrary to our musings about stability developing a month ago, the Canadian bond market fluctuated significantly during July. Yields initially declined, but jumped higher following robust U.S. labour market data. They subsequently fell for the next two weeks before rising again. The Canadian market tended to follow the movements in the U.S. bond market, rather than reacting to Canadian economic fundamentals. In the United States, investors were primarily focused on the possible start date of the Federal Reserve tapering its monthly bond purchases. The DEX Universe bond index earned +0.19% in the month.

Continuing the trend of recent months, Canadian economic data during July indicated sub-par growth. Unemployment held steady at 7.1%, but job creation stalled. Growth in Canadian GDP during the most recent 12 months was slightly less than expected at 1.6%. International trade figures added to the gloom, with both imports and exports declining. More positively, retail sales were stronger than expected and the Canadian housing sector held steady, thereby defying predictions of an imminent collapse. Not surprisingly, the Bank of Canada left its monetary policy measures unchanged at its July rate-setting meeting.

U.S. economic data also indicated disappointingly slow growth. Both retail sales and construction spending were weaker than consensus expectations, but unemployment held steady due to good job creation. In the housing sector, the number of new starts fell, but prices continued to climb and homebuilders were much more optimistic about future demand. The estimated pace of growth in U.S. GDP during the second quarter was revised sharply higher, but that good news was offset by lower estimates of first quarter growth. Overall, it was apparent that the U.S. economy had significant headwinds in the first half of 2013 as a result of increased taxes and reduced spending by the federal government.

In July, it seemed that U.S. economic analysis was focused almost exclusively on whether the latest bit of information about the economy might influence the Fed to change its bond buying programme. A consensus developed that the base case for when the Fed would begin tapering its purchases was most likely in September. Stronger than forecast data were thought to reinforce the likelihood of that timing, while weaker data gave credence to possible delays to the Fed’s tapering until October or even later. With many market participants taking vacations in July, liquidity in the bond market was reduced, which meant that economic surprises caused greater than normal price and yield volatility.

The Canadian yield curve steepened in July, as shorter term yields moved modestly lower while long term yields edged higher. The yield of 2-year benchmark Canada Bonds, for example, fell 7 basis points, while 30-year Canada Bond yields rose 7 basis points. Of particular note, 30-year Canada Bond yields briefly rose above 3.00% for the first time since October 2011. Long term yields hit an all-time low of 2.19% in July 2012, and were as low as 2.35% as recently as last May. The federal sector earned 0.14% in the month, with gains on short term bonds offsetting losses on longer term issues. The provincial sector returned -0.02%; the longer average maturities of provincial bonds meant that most had their yields increase in the period. In addition, provincial yield spreads edged 1 basis point wider. The corporate sector returned 0.47% in the month. Investor demand for corporate bonds was robust, as new issue supply was over $9 billion and corporate yield spreads still tightened by a basis point. Real Return Bonds earned 1.03% in July, rebounding somewhat from substantial losses in May and June.

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