Economic data took a back seat in December, as bond market participants focussed on the noisy, acrimonious debate to resolve the U.S. fiscal cliff. Speculation and rumours that a deal had been struck to reduce the scheduled tax increases and spending cuts persisted through the month, leading generally to lower bond prices. Without a deal, the U.S. economy was expected to enter a serious recession in early 2013, so optimism that the fiscal cliff could be averted caused rallies in riskier assets, such as stocks, and declines in the value of safe haven assets like bonds. Late in the month, with no deal yet achieved and time running out, bond prices rebounded thereby reducing earlier losses. The DEX Universe Bond index fell 0.13% in the month.

Canadian economic news in December was mixed, although it had a generally positive message. Of particular note, the Canadian unemployment rate fell to 7.2% as 59,300 new jobs were created in the most recent month. That was certainly good news but, from a longer term perspective, improvement in the Canadian labour market has become increasingly difficult to come by. A year earlier, the unemployment rate stood at 7.5%, and economic growth in 2012 has been too slow to generate a more rapid recovery. Other positive data in December included stronger than expected retail sales, robust housing starts, and stronger than expected capacity utilization. Inflation remained subdued, with the year-over-year increase in CPI falling to 0.8% from 1.2% a month earlier. Less positively, Canadian GDP growth was only 0.1% in the most recent month, and only 1.1% stronger than year ago levels. In addition, Canadian factory sales fell 2.4% in the most recent month, with inventories of unsold stock rising as a result. International investor demand for Canadian bonds was very strong at $15.5 billion, including $8.9 billion in corporate bonds. Most of the corporate total, though, reflected heavy new issuance by Canadian companies of US dollar denominated issues. The Bank of Canada left interest rates unchanged as expected. Interestingly, the Bank attributed the economic weakness in the third quarter to transitory disruptions in the energy sector and projected acceleration in subsequent growth.

Canadian Labour Market

U.S. data continued to be distorted by Hurricane Sandy and its aftermath, but generally showed an economy that improved in spite of the fiscal cliff debate. Unemployment fell to 7.7% from 7.9%. Industrial production was stronger than expected, partially due to a Sandy-related rebound, but also from higher capital spending. Household net worth increased in the third quarter by 2.7% from the previous quarter, buoyed by higher equity and home prices. The housing recovery continued as prices showed further improvement in recent months, according to a number of surveys. Rising home prices will have two positive implications for the U.S. economy. First, they will encourage previously reluctant buyers to enter the market, boosting new home construction and existing home sales. The second impact will be through the so-called wealth effect; consumers are more optimistic and likely to spend when their net worth is rising. For most Americans, their home is their most valuable asset, and higher prices will encourage them over time to spend more.

US House Prices [rate of change]

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