Internationally, there was a resurgence of COVID-19 cases in several European Union countries. This led some EU countries, including Germany and France, to extend their wage support programmes by up to a year, which will result in additional borrowing needs. In addition, there was no progress in the latest round of Brexit talks, increasing the likelihood of a disruptive no-deal departure from the EU by Britain at the end of the year.

The Canadian yield curve steepened in August as 2-year Canada yields edged higher by 2 basis points while 30-year yields increased 24 basis points. The steepening of the Canadian curve closely followed that of the U.S. curve which saw 2-year Treasury yields rise by 3 basis points and 30-year yields up 26 basis points. The increases in longer term yields in both countries appeared to be due to better than expected economic news, particularly in the first half of the month, and slightly higher risk of future inflation if the respective central banks allow inflation to temporarily exceed their 2% targets because of earlier shortfalls.

In August, federal bonds earned -0.90%, as higher yields resulted in lower bond prices. The provincial sector returned -1.75% in the month. The longer average duration of provincial bonds meant larger price declines as yields rose. However, provincial yield spreads narrowed by an average of 3 basis points, mitigating some of the impact of higher yields. Investment grade corporate bonds returned -0.51%. Corporate yield spreads narrowed 8 basis points on average, which helped the sector perform better than government bonds. New issue supply of $6.4 billion was typical of a normal summer month following robust issuance in the spring, however demand for new issues remained strong, with most deals heavily over-subscribed. High yield bonds returned +2.05% in August, following the lead of rallying equity markets. Real Return Bonds earned +0.92%, as investors ignored the surprisingly low CPI result and worried about future inflation accelerating more than previously expected. Preferred shares continued to recover from their plunge in March, gaining another 4.55% in August. A significant factor in the rise in preferred share prices was the announcement by the Royal Bank that it would be redeeming $1.5 billion of legacy perpetual preferred shares that would no longer qualify as Alternative Tier 1 (AT1) capital after next year. The redemption notice followed the bank’s issuance in July of $1.75 billion of Limited Recourse Capital Notes that qualified as AT1 capital and had a substantial cost saving for the bank. In addition, another issuer announced the redemption of $172 million of one of its series of preferred shares. Preferred share prices rose as investors looked for replacements for the redeemed issues and anticipated additional redemptions, particularly by banks choosing to issue LRCN instead of preferred shares.

More current customer transaction data from some Canadian banks shows activity leveling off in August following strong growth previously. As well, some pandemic-support programmes are winding down including wage supports and rental deferrals. The Office of the Superintendent of Financial Institutions (OSFI), for example, announced that it was ending its temporary support for banks providing deferrals of mortgage and other loan payments. As a result, banks will no longer be able to count deferred loans as current but will have to put additional capital aside to cover potential loan losses. In the last two quarters, Canadian banks have been increasing their reserves for bad debts, but it is uncertain that they will be sufficient as deferrals end, wage supports are terminated, and delinquencies rise.

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