With global investors continuing to focus on the potential timing of the U.S. Federal Reserve tapering its bond purchases, stronger economic data led to higher yields and lower bond prices in early November as it was thought it would hasten the Fed’s decision. In many bond markets, including Canada and the United States, the lower valuations appeared to bring out bargain hunters and bond prices recovered most of their losses by month end. The DEX Universe declined 0.24% in the period.

Economic data in Canada was generally a little stronger than expected in November. Housing starts rose slightly from upwardly revised totals the previous month. Retail and manufacturing sales were better than forecasts, while the trade deficit fell as exports grew more quickly than imports. Growth in Canadian GDP during the third quarter was estimated to have been at a +2.7% annual pace, above economists’ expectations. The unemployment rate held steady at 6.9%, as job creation was satisfactory. The only worrisome news was that inflation fell to 0.7%, below the 1%-3% target band, and reinforcing the Bank of Canada’s concern that inflation was not bouncing back toward its 2% target.

International security transactions data for the most recent month, September, showed that foreign investors were net sellers of Canadian bonds. International interest has been declining for several months and reflects a number of factors. Reduced concerns about the European debt crisis and increasing optimism regarding global growth have lessened the safe haven bid for Canadian investments. In addition, Canada’s slower economic growth has made us a less attractive target for international investors. As well, central banks in some emerging market countries are thought to have sold foreign exchange assets, including Canadian bonds, in efforts to stabilize their own currencies. Interestingly, during November, in contrast with the recent trend away from Canadian bonds, one central bank appeared to establish an initial position in Canadian dollars with the purchase of over $2 billion of short term Canada bonds in a single day.

Net Foreign Purchases of Canadian Bonds

The reduced demand for Canadian bonds has been a factor in the decline of the Canadian exchange rate during 2013. The record foreign interest in Canadian bonds from 2010 to early 2013 played a significant role in pushing the Loonie to uncompetitive heights versus the U.S. dollar. As the bond demand has receded in recent months, the exchange rate has moved lower, hitting its weakest level in over three years. If the exchange rate continues to decline, that will make Canadian exporters more competitive and help accelerate Canada’s economic growth. Disappointing export volumes have been identified by the Bank of Canada as one of the reasons it is maintaining its stimulative monetary policy, so the weaker exchange rate may eventually allow the Bank to raise rates.

Canadian Exchange Rate

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