The Canadian yield curve moved higher in the month with a nearly parallel shift. The yields of 2 and 30-year Canada Bonds rose 16 and 19 basis points respectively, while mid term yields increased slightly more. Higher yields meant lower bond prices and federal issues declined 1.21% as a result. Provincial issues declined 1.85% on average as their longer durations resulted in greater price changes. Corporate issues returned -0.99% in the month. Their yield spreads narrowed marginally, which was interesting because new issue supply was less than half of the previous two months’ levels. Non-investment grade corporate bonds earned +1.38% in April, with energy-related issues having particularly strong performance with the rebound in oil prices. Real Return Bonds declined 1.33%, thereby outperforming nominal bonds on a duration-equivalent basis.

We do not presume to be experts on energy prices, but it appears that oil has bottomed and is gradually recovering some of the losses suffered since mid-2014. The recovery in oil prices has not gone unnoticed in the foreign exchange market as the Canadian dollar has been the strongest major currency in the last three months. The correlation between the Loonie and oil is a longstanding one, and could be problematic, if oil continues to move higher. The Canadian economy is struggling because high consumer debt levels and needs business investment and exports to grow. If the exchange rate continues to appreciate, non-oil exports will suffer and businesses will likely defer investment. In that scenario, the Bank of Canada would likely consider another interest rate reduction, notwithstanding the distortions the current low rates are causing to the economy and markets.

Spot Returns (%) Versus the U.S. Dollar

We are not entirely surprised that European bond yields would rise during the ECB’s quantitative easing programme. As we noted in early February with the chart below, the United States tried quantitative easing three different times in recent years and bond yields tended to rise rather than decline as the Fed was making its purchases. The same may happen with quantitative easing in Europe, because anticipation of the programme caused a large drop in yields that may not prove sustainable. If European bond yields continue to move higher, North American yields will likely follow.

Yield of 30-Year U.S. Treasury Bonds

Portfolio durations are currently somewhat shorter than benchmarks to protect against further declines in bond prices. We are monitoring the market closely for indications that the selling pressure is abating. The yields of short term bonds are unsustainably low without further easing by the Bank of Canada, and we prefer to hold a combination of cash equivalents and longer term bonds instead. In addition, we are moving some mid-term holdings into slightly longer maturities to take advantage of the relatively steep yield curve. Among the sectors, we are underweight federal issues, neutral regarding provincial bonds, and overweight corporate issues. We are considering adding to Real Return Bonds as a hedge against inflation rebounding with oil prices.

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