Concerns about Chinese economic growth slowing caused remarkable volatility in equities, commodities, and exchange rates during August. As a result, demand for the safe haven asset class, bonds, also fluctuated considerably in the month. In the end, though, bond investors focused on the strength of the U.S. economy and the possibility that the U.S. Federal Reserve would start raising interest rates in September; bond prices declined and yields rose from month earlier levels. The FTSE TMX Canada Universe Bond index declined 1.00% in the period.

The catalyst behind the Chinese growth concerns was a continued selloff in that country’s equities. After a long and large bull market, Chinese stocks peaked in June and have been declining since then. During August, there were several days of very sharp declines in the market composites, which prompted the government to intervene with trading restrictions, lower interest rates, and removing restrictions on pension funds from buying equities. Globally, investors interpreted the falling Chinese equity prices to be an indication of deteriorating conditions in the world’s second largest economy. That led to a rout in commodity prices, as copper fell more than 7%, nickel plunged more than 15%, and oil dropped close to 20% part way through the month. Global equity markets also fell in response to the diminished outlook for Chinese growth implied by falling Chinese equities. In an indication of the volatility, the Dow Jones stock index fell over 1,000 points during the first hour of trading on August 24th, before recovering somewhat over the balance of the day. In the last three days of the month, equities and commodities staged a strong recovery that erased some or all of the earlier losses.

How did the bond market react to the gyrations in global equity markets? In large part, bond investors took to heart the comment by Nobel prize-winning economist Paul Samuelson who once observed that U.S. stock markets had predicted 9 of the last 5 recessions. In other words, while equity investors clearly anticipate future economic growth, the stock markets occasionally become over-valued in their own right and experience corrections (i.e. declines of 10% or more) unrelated to the economic environment. With many observers pointing out that U.S. stock markets had not had a correction for several years, the current selloff appeared to be a healthy re-evaluation of equity values and not a panic related to a sudden slowing of the U.S. economy.

But what about the Chinese stock market and its fall in the last two months? Should we anticipate further slowing in Chinese growth, because their stocks are selling off? If the U.S. stock markets are poor economic indicators, the Chinese markets are far worse ones. The Chinese stock markets are unsophisticated, only just developing, and subject to considerable speculation. The markets are dominated by retail investors, who appear to often focus on momentum trading, rather than fundamentals. As well, relatively few Chinese citizens actually own stocks. So it appears that the recent decline in those markets does not tell us much about the pace of growth in the world’s second largest economy. When one realizes that in the last year the Shanghai equity composite rose more than 150% before starting to correct in June, and that it is still up substantially from year ago levels, it is difficult to conclude much about the Chinese economy from the recent gyrations.

The Shanghai equity composite rose more than 150% before starting to correct in June 2015.
Instead of reacting to the volatility in stock markets, bond investors focussed on healthy economic data coming out of the United States. As well, some bond investors also worried about the possibility that the Fed might still raise interest rates in September. Contradictory comments from different Fed speakers were somewhat confusing, but left the impression that some of them still considered a September move possible. We also believe some global central banks, particularly those of emerging market countries, were sellers of U.S. Treasuries and Canada Bonds as they sought to support their respective currencies and bolster their economies as commodity prices have fallen. Selling of shorter benchmark Canada issues had the effect of causing interest rate swap spreads to narrow. Combined with widening yield spreads on fixed rate agency and provincial issues, this caused a widening of floating rate note yield spreads. Longer term Canada bonds followed the lead of U.S. Treasuries to lower prices and higher yields.

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