The Canadian bond market experienced a rare decline in October, with the broad DEX Universe bond index falling 0.43%. It was the first monthly loss since March and only the third one this year. The European sovereign debt crisis once again dominated market activity, with economic developments having much less impact. Investor sentiment swung back and forth between optimism that the Greek insolvency could be contained and pessimism that it could not be resolved and that a credit crisis and economic chaos would follow as consequences.

As a result, the bond markets experienced some of the greatest volatility in memory during October. This was particularly evident in the benchmark 30-year U.S. Treasury bond. Normally, long term bond yields do not move 25 basis points in a month. This month, however, the yield swung between 2.76% and 3.45%, a range of 69 basis points. As can be seen in the chart below, the resultant price changes were unusually large. The volatility was caused, in part, by reduced liquidity in the market as many investors reacted to ongoing headline risk by withdrawing from active trading. And headline risk was abundant, as announcements about the progress of the European debt crisis were frequently contradicted by official statements the very next day.

Price of 30 year US Treasury Bond in October

The Canadian bond market took its lead from the U.S. market in October, but did not experience quite as much volatility. As an example, the benchmark 30-year Canada bond traded in a very wide 10 point price range during the month, but this was less than the 16 point price range of long Treasuries.

The bond markets began the month with rising prices as news that the European debt crisis forced a bailout of a major bank, Dexia, by France and Belgium led investors to fear spreading financial contagion. Subsequent news, though, that European officials were contemplating recapitalizing all European banks prompted optimism that a credit crisis could be averted. Equity markets globally reacted very positively, and the stock rally received further support from indications that a more comprehensive solution to the debt crisis was being developed. The renewed optimism led to a steady decline in bond prices as the flight-to-safety demand for fixed income was reversed. The selloff in bonds culminated with the announcement of the expansion of a European bailout fund and agreement on further writedowns of Greek debt on October 27th. Lack of specific details for both of these developments, however, caused steep declines in stock prices and sharp gains for bond prices for the balance of the month. On balance, though, stock markets enjoyed strong gains for the month, with the S&P/TSX gaining 5.6% and the U.S. based S&P500 jumping 10.9%, while bond markets finished somewhat lower.

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