The Canadian bond market eked out a small gain in April, as shorter term yields rose and longer term yields fell slightly. Disappointing economic data in Canada, as well as globally, made investors more cautious and that pushed government yields lower. Partially offsetting the impact of weaker growth was a more hawkish stance from the Bank of Canada that led to higher short term yields. The DEX Universe Bond index earned 0.13% in the month.

Canadian economic data started the month positively with a drop in the unemployment rate to 7.2% from 7.4%. The fall in unemployment was the result of robust job creation in March following several months of little or no new jobs. In addition, housing starts accelerated from already good levels, but this news was tempered by analysis that showed the improvement came primarily in the overheated Toronto condo market. Starts of buildings with multiple units rose 8% nationally, with Ontario up  a remarkable 50%. The pace of multiple unit starts in Canada has doubled in the last three years, leading many observers to question its sustainability. In contrast with the multiple units data, starts of new single-family homes actually declined by more than 2%. Later in the month, the data turned decidedly negative with reports of falling manufacturing sales and retail sales in Canada. In addition, Canadian monthly GDP unexpectedly shrank 0.2% due to weakness in the mining, oil and gas, and manufacturing sectors. While some of the weakness reflected temporary shutdowns in the mining sector, the breadth of the slowing was worrisome.

The Bank of Canada left interest rates unchanged at its scheduled rate setting meeting in April, but the accompanying statement surprised the market by suggesting rates might need to rise before the end of the year. The Bank had been similarly warning the markets last summer that it might need to raise rates, but it stopped with the sharp drop in confidence in the aftermath of the U.S. debt ceiling debacle and the European sovereign debt crisis. The April warning came as the Bank revised upward its expectations for economic growth and inflation, while reducing its estimate of slack in the Canadian economy.

In the United States, after six months of economic activity exceeding economists’ expectations, economic data during April generally disappointed observers. The weakness was broadly based, with construction, auto sales, industrial production and job creation falling short of forecasts. Initial claims for unemployment benefits unexpectedly moved higher, while consumer confidence declined slightly. Housing starts dipped, although building permits (a leading indicator of starts) actually rose. On the positive side, home prices appeared to stabilize on a month over month basis, although they continued to decline versus year ago levels. Internationally, economic data also tended to be weaker than expected. Equity markets reacted to the disappointing data with considerable volatility and generally lower prices.

The Bank of Canada’s more hawkish rhetoric led to a rise in short term yields as investors revised their expectations of when the first rate increase might occur. During the month, 2-year yields rose 14 basis points while 5-year Canada bond yields increased 3 basis points. In contrast, yields of longer term bonds actually fell during April, as Canada benefitted from international investors seeking a safe haven. Yields of 30-year Canada bonds, for example, fell 5 basis points. The best performing term along the yield curve was 10-years, where the yields fell 8 basis points. With short term yields rising and long term yields falling, the yield curve flattened considerably. This extended the flattening trend that has been apparent for the last few months, during which the difference between 2 and 30-year bonds has fallen from 200 basis points to 120 basis points.

Canadian Yield Curve Flattens

The shift in the Canadian yield curve during April was quite muted compared to that of the U.S. yield curve. The disappointing economic data caused a strong rally in the U.S. bond market with yields of U.S. Treasuries maturing in 5 years or longer falling 23 to 30 basis points. Even 2-year Treasury yields fell marginally, because the Fed was thought unlikely to raise interest rates before 2014.

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