U.S. economic data was also positive in December. The unemployment rate remained at 3.7%, the lowest since the 1960’s. The positive labour situation encouraged consumers, as retail sales were above forecasts and consumer debt rose by the most in 11 months. Surveys of manufacturing and non-manufacturing businesses as well as consumers all showed better than expected optimism. On December 19th, the U.S. Federal Reserve raised its interest rates for the fourth time in 2018. The Fed’s decision had been widely expected, but repeated criticism of the Fed and its chairman, Jay Powell, by president Trump had created some uncertainty. In the end, the decision to raise rates reflected both economic considerations and the need for the Fed to demonstrate its independence from political interference.

Bond yields in both Canada and the United States fell sharply in December. In this country, the yields of 2, 5, and 10-year Canada bonds dropped 30 to 32 basis points in the month, while the decline in 30-year yields was slightly more subdued at 21 basis points. The low absolute level of long yields of less than 2.20% likely reduced interest in those bonds. In the United States, the yields of U.S. Treasuries of all maturities, including 30-year bonds, fell between 30 and 34 basis points.

Federal bonds were the top-performing sector in December, returning 1.67% in the month. Provincial bonds returned 1.28%, as the benefit of a longer average duration was offset by their yield spreads versus Canada bonds widening by 14 basis points. The yield spread of investment grade corporate bonds also widened by 14 basis points, which caused their returns to trail government bonds, earning only 1.06% in the month. Real Return Bonds shrugged off the weak CPI data and earned 1.46% in December. Non-investment grade bonds struggled in the risk-off environment and returned -0.21% in the period. Preferred shares also fared poorly in the period, but a strong rally late in the month limited their decline to only -1.58%.

In December 1996, then-chairman of the U.S. Federal Reserve Alan Greenspan made a famous remark about the “irrational exuberance” of the stock markets. Twenty-two years later, sharp selloffs in equities and other so-called risky assets during a period of strong economic activity led one observer to label this past month’s activity as “irrational despondence”. We tend to agree. Current economic conditions are quite good, so the impact of the U.S.-China trade war is not likely to cause a recession. We do anticipate that growth in both Canada and the United States will be slower in 2019 than in 2018, but it will remain positive. We expect the Canadian economy will grow by 1.5% to 2.0% and the U.S. by 2.0% to 2.5% in 2019. Combined with inflation rates that are stable around 2.0%, neither the Bank of Canada nor the Fed will need to raise interest rates more than twice this year.

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