The bond market rally continued in August. Investors focussed on potential European Central Bank measures to stimulate that area’s growth and avoid possible deflation developing. Geopolitical concerns, particularly Ukraine/Russia, also generated some demand for bonds. Economic developments in Canada and the United States were generally good, but ignored by the market as central bankers in both countries reiterated their dovish concerns about the durability of the expansion. The FTSE TMX Canada Universe Bond index returned 1.07% in the month.

In Canada, the unemployment rate declined to 7.0% from 7.1%. Statistics Canada had some problems with its Labour Force Survey (LFS), and was forced to issue a correction to its estimate of job creation. In the end, it said 41,700 new jobs had been created in the month, but that good news was diminished by the fact that all of the jobs were part-time ones rather than better quality full time ones. Another problem with the LFS arose when Statscan released its Survey of Employment, Payrolls and Hours (SEPH). The LFS, which is based on a sampling of households, has shown weak job creation so far this year and that has been one factor behind the Bank of Canada’s reluctance to raise interest rates. The SEPH, which is based on polling employers and considered by many economists to be more reliable, has indicated significantly greater job creation than the LFS. In the most recent 12-month period, the SEPH registered 230,000 new jobs compared with only 72,300 positions in the LFS. While the two surveys tend to track each other fairly closely over the long term, the current difference is rather large and calls into question whether the Bank of Canada’s assessment of the economy is correct. If the SEPH proves to be a better indicator of the current labour situation, there is less slack in the Canadian economy and  the Bank will need to raise interest rates sooner than many observers expect.

In other Canadian economic data, Canadian GDP grew at a faster than expected 3.1% pace in the second quarter, with average weekly earnings rising at a rate of 3.3% during that period. Stronger than expected income growth helps explain how consumers could afford to keep spending, as retail sales increased more than forecasts. Canada’s trade surplus was also much better than expected in the most recent month (June), with exports rising 1.1% to a record, while imports fell 1.8%. Building permits were also higher than forecasts on non-residential activity, suggesting continued strength in the construction sector. Inflation declined to 2.1% from 2.4% the month earlier, but remained above the Bank of Canada’s 2% target for the third consecutive month.

In the United States, the labour situation continued to improve. The unemployment rate rose to 6.2% from 6.1% as discouraged workers returned to the labour force following six consecutive months of more than 200,000 jobs being created. Claims for unemployment benefits fell to low levels, and the number of job openings rose to the highest level since 2001. Consumer confidence rose with the improving job situation, although retail sales disappointed during the month. Surveys of manufacturers and the service sector showed increasing activity and business investment spending was robust. Even the stuttering housing sector showed improvement, with starts of new homes rebounding, and sales of new homes stronger than expected.

In contrast with North American data, Eurozone economic news was disappointing. Second quarter GDP was weaker than anticipated, showing no growth in the period. European industrial production unexpectedly fell and construction activity also declined. Unemployment showed no improvement and remained at the high 11.5% level. Concerns about potential deflation increased as inflation declined to only 0.3%.

The Eurozone has struggled for the last three years to recover from its sovereign debt crisis and forced fiscal austerity. The lack of economic strength and the risk of deflation have led many observers to anticipate that the European Central Bank would launch its own quantitative easing programme, similar to the U.S. Federal Reserve’s one that is currently being wound down. The Ukraine crisis has exacerbated Europe’s economic problems because it has borne a substantial portion of the sanctions against Russia. As a result, speculation about ECB quantitative easing has increased sharply as sanctions have increased and European trade prospects dimmed. European government bond prices rose and yields fell sharply as investors anticipated that the ECB would soon start buying the bonds. As can be seen in the table below, European yields have fallen sharply in the last few months. Remarkably, even Spanish yields have fallen below comparable U.S. yields, notwithstanding the need for Spain to be bailed out three years ago.

Yields of 10-Year Government Bonds

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