The Canadian bond market rebounded from losses early in the month to finish December with a small gain. Economic data in both Canada and the United States was stronger than expected, and that prompted some initial selling of bonds. The Canadian bond market was also impacted by a sharp selloff in the U.S. bond market following an agreement in that country to provide additional fiscal stimulus that would significantly increase the fiscal deficit. The subsequent rebound in bond prices came as bargain hunting by some investors led to out-sized price increases in illiquid yearend market conditions. The DEX Universe Bond index rose 0.16% in the month and 6.74% for all of 2010.

As noted above, Canadian economic data received in December was generally stronger than expected. In many cases, though, special circumstances were responsible for much of the apparent strength. The unemployment rate fell to 7.6% from 7.9%, although much of the decline was due to a drop in youth unemployment as many young people left the labour force to return to school. Retail sales increased robustly, but rising gasoline prices were a major factor. Housing starts jumped 11.6% from the previous month, but the gains were not well distributed; strong starts of urban multi-unit housing in Ontario offset weaker results in other provinces and in single-family homes. Among the less ambiguous data, Canadian industrial capacity utilization climbed for the fifth consecutive quarter. Capacity utilization in the manufacturing sector, in particular, has recovered to pre-crisis levels. It was also a positive to learn that inflation had reversed much of the previous month’s upward spike, falling from 2.4% to 2.0%.

In the United States, there were tentative signs that the labour market was finally improving. While the unemployment rate ticked up to 9.8% from 9.6%, the number of job openings rose and layoffs fell. In addition, weekly claims for state unemployment benefits fell below 400,000 for the first time in 2½ years. Small business optimism rose to the highest level in three years and that led to an important increase in hiring intentions. Improvement in the job situation led to increased consumer confidence and greater spending. Retail sales were stronger than expected and consumer credit expanded for the second consecutive month following declines in 18 of the previous 19 months. Motor vehicle sales rose to an annual rate of 12.5 million, well off the 9.3 million low hit in early 2009, although still below the typical 16 million pace prior to the financial crisis. Industrial production was stronger than anticipated and capacity utilization continued to improve. Only the housing sector remained depressed, with starts and sales failing to increase and home prices falling marginally.

Corporate bonds marginally outperformed provincial issues, with the two sectors returning 0.30% and 0.28%, respectively. The corporate sector was propelled by strong performance in mid-term financial issues as they rebounded from spread widening in November. In the provincial sector, long term issues narrowed 2 basis points generating the best gains. In contrast with corporate and provincial bonds, Canada bonds earned an average of only 0.01% in December.

The Canadian yield curve moved slightly higher in the month. The shift was a parallel one with yields across all maturities increasing 4 to 6 basis points. That was in stark contrast to the shift in the U.S. yield curve. In that market, mid-term bond yields rose substantially more than either short or long term issues. Yields on 5 and 10-year U.S. Treasuries rose roughly 50 basis points in reaction to the stronger economic data, while longer term Treasury yields increased a more muted 23 basis points. Yields on 2-year bonds rose only 13 basis points, because of the low probability of a Fed rate increase in the next few quarters even with stronger growth.

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