The Canadian yield curve flattened further in August as 2-year yields held steady while longer term bond yields declined 8 basis points. The lack of movement in 2-year yields reflected the consensus that the Bank of Canada probably would be raising interest rates again at its October meeting. The decline in longer term yields reflected concerns that future Canadian growth might be negatively impacted by U.S. protectionism. Yields of 30-year Canada bonds briefly moved lower than 10-year yields during the month as pension funds and life insurance companies continued to search for long duration assets and ignored the low real (i.e. after-inflation) yields of long term bonds.

The federal sector returned 0.64% in the period, as lower yields meant higher bond prices. Provincial bonds returned 0.81% on average; a 2-basis point widening of yield spreads partially offset the longer average duration of the sector. Investment grade corporate bonds earned 0.82%. Corporate yield spreads tightened by a basis point, with new fixed rate issues totalling $7.1 billion in the month. Non-investment grade corporate bonds earned 0.54%, modestly underperforming higher quality issues. Real Return Bonds returned 1.13% but underperformed nominal bonds on a duration-adjusted basis. Preferred shares returned 0.80% in August.

In specific issuer news, Moody’s downgraded Ford to Baa3, one notch above non-investment grade status, and left the outlook as negative. The potential that the company could be downgraded to junk caused selling of Ford bonds and their credit spreads widened by 15 basis points. Other auto companies’ bonds experienced minimal or no spread widening on the Ford news. We do not hold Ford bonds.

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