The Canadian yield curve flattened slightly in April as longer term bond yields declined more than shorter term yields. The yield of 2-year Canada bonds declined 11 basis points, while 30-year yields fell 20 basis points. The mid term section of the yield curve fared well, with 5 and 10-year yields going down by 22 and 17 basis points, respectively. Canadian bonds did better than U.S. ones, as 2 and 30-year Treasury yields fell only 5 and 7 basis points, respectively.

Federal bonds earned 1.55% in April as lower yields resulted in price gains. The provincial sector returned 5.27% in the month, helped by its longer average duration and a 25 basis point compression in yield spreads. Investment grade corporate bonds gained 4.75%, as their yield spreads narrowed by an average 54 basis points in the period. As in the U.S. bond market, investor demand for corporate bonds was very strong, which permitted the highest new issue activity on record. New issues totalled $19.2 billion, with TD Bank, CIBC, and TransCanada Pipelines each bringing multi-billion dollar deals. High yield bonds returned 2.62% in April, underperforming higher quality issues as creditworthiness remained very uncertain. Real Return Bonds gained 3.57%, ignoring the drop in CPI, as investors worried that the recently announced, massive fiscal stimulus measures might eventually lead to higher inflation. Preferred shares continued the rebound from their low reached on March 23rd and gained 12.68% in April.

Governments and central banks have reacted swiftly and forcefully to mitigate the impact of the recession. However, we expect the economic news over the next month or two to be epically bad. Ultimately, it will be the path of the pandemic that will determine the length and depth of the recession. Only when infection rates drop sufficiently that physical distancing can be substantially reduced will the Canadian and global economies begin to recover. In Canada, some provinces are starting to plan the reopening of their economies, but the two largest ones, Ontario and Quebec, appear to be weeks away from sustained declines in infections. Globally, the world’s largest economy, the United States, is tragically suffering from incompetent leadership that has resulted in it having a third of worldwide COVID-19 infections and a quarter of the deaths. Notwithstanding president Trump’s exhortations for governors to quickly re-open their respective states, and improve his election chances, the U.S. economy seems unlikely to fully re-open until mid-year.

Unfortunately, the longer the Canadian economy or that of any other country remains mostly shut down, the more intractable the economic damage becomes. Although consumer spending will rise as physical distancing measures are relaxed over time, the unemployment rate will only fall gradually, suggesting that it will be a protracted recovery for household spending. With many small businesses already declaring bankruptcy, there simply won’t be jobs to return to for many people. In addition, businesses are unlikely to increase investment spending until there is greater clarity regarding future profitability. We believe that the recovery will take at least two to three years. Until then, the Bank of Canada will leave its interest rates close to zero, and a substantial rise in bond yields seems unlikely. We are, therefore, cautiously optimistic that yields may decline modestly further in the near to medium term.

In addition, anticipation of seasonal flows and index changes in early June should have a significant positive impact on Canadian bonds during May. Approximately $68 billion of coupons and maturities will need to be reinvested in June, much of it coming on June 1st and 2nd. In addition, the Universe Bond index duration will extend an unusually large 0.22 of a year next month as a result of June 2021 bonds no longer qualifying for the index. Many investors will adjust their portfolios in May to take into account these changes.

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