Canadian bond prices fell slightly and yields rose marginally in August. However, the relatively small changes over the whole month belied the volatility that occurred within the period. The DEX Universe Bond index, for example, declined 0.10% in August, having been down as much as 1.35% mid-month before rallying back. Long term bonds experienced even greater volatility. The DEX Long Term Bond index fell 2.77% in the first half of the month, but rebounded to finish down only 0.49%. Price changes of more than 1% occurred on several days. A significant factor behind the volatility was reduced liquidity due to summer vacations. With many investors, both in Canada and abroad, taking time off, trading activity tended to move prices more than usual.

The selloff in the first half of the month did not appear to have any specific catalyst. Rather, an absence of bad news from Europe reduced demand for bonds, while some positive economic data prompted selling. With liquidity reduced, the impact was unusually large. Benchmark 30-year Canada bonds, for example, plunged 5% in price before rebounding later in the month. The rebound was spurred by bargain hunting from investors wanting to take advantage of somewhat higher yields, as well as a resumption in headlines concerning the European debt crisis and some negative economic developments in the United States.

Canadian economic data were decidedly mixed in August. Unemployment rose to 7.3% from 7.2%, as job creation was disappointing. Manufacturing sales fell 0.4% because of weak petroleum and coal sales but, excluding that sector, sales actually rose 1.1%. Housing starts declined, but remained at a relatively high level. Economic activity in June was stronger than expected, leading to 1.8% growth in GDP in the second quarter that was above economists’ expectations. Inflation remained dormant, with prices actually falling marginally in the most recent month. International investors reduced their holdings of Canadian bonds by $7.8 billion; $17.5 billion of maturities were partially offset by $9.8 billion of purchases of longer term bonds. All in all, there was little evidence that the Bank of Canada needed to adjust monetary policy.

In the United States, there was considerable speculation regarding the Federal Reserve initiating another quantitative easing stimulus programme, dubbed QE3. Quantitative easing involves the central bank buying government bonds to raise their prices and thereby lower yields; lower yields encourage consumer and business borrowing that result in increased economic activity. Statements by the Fed following its August meeting and a speech by Chairman Ben Bernanke at the Fed’s annual Jackson Hole conference hinted at QE3 if U.S. unemployment did not fall from its current unacceptably high level. No timetable for possible implementation was given, but many investors speculated that it could commence as soon as September. If and when QE3 does occur, it would be positive for bonds, so the speculation about it during August caused rallies in the bond market.

U.S. economic news in August tended to be stronger than expected, making the likelihood of QE3 difficult to predict. Job creation surprised to the upside (although unemployment inched up as well). Construction spending was stronger than expected, retail sales had robust increases, and industrial production saw good improvement, too. The housing sector continued to recover, with prices rising on a year-over-year basis and building permits moving sharply higher. Late in the month, the data turned more negative, as capital spending plans fell and consumer confidence dropped. The uncertainty surrounding the looming cessation of tax cuts and various spending programmes in early 2013 (the fiscal cliff) was thought to have contributed to increased caution by both businesses and consumers.

Globally, economic growth continued to slow. The Chinese economy decelerated further, suggesting the need for further stimulus to avoid a hard landing. Japanese retail sales fell, Indian industrial production declined, and German retail sales unexpectedly dropped. No country demonstrated better than expected growth. Instead, economic malaise seemed to be pervasive.

The Canadian yield curve executed a near-parallel shift upward in August. Yields across all maturities rose 6 to 9 basis points. On a day to day basis, Canadian bonds generally tracked U.S. Treasury bond movements quite closely. The increase in yields caused federal bond prices to decline modestly, leading to a 0.22% decline in the sector.

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