Global bond prices declined as yields rose during December, and Canada’s bonds followed suit. The main catalyst for higher yields was the announcement that China and the United States had reached agreement on Phase 1 of a trade deal. While details of the agreement were not disclosed and it remains to be signed by both countries, investors reacted with relief that trade tensions were going to be reduced thereby lessening the negative impact on global economic growth. As a result, there was a shift from the safe haven of bonds to riskier assets such as common stocks and preferred shares, which led higher bond yields and lower prices. In addition, global central banks looked unlikely to add to existing monetary stimulus, such as by lowering interest rates in the next few quarters. The reduced potential for rate cuts in the near term reinforced the weakness in the bond market. The FTSE Canada Universe Bond index returned -1.19% in December.

Canadian economic news received during December was generally negative, although some of the data was likely distorted by the effects of the U.S. GM strike during October. Of particular concern, the unemployment rate jumped to 5.9% from 5.5% the previous month, as 71,200 jobs disappeared. The market reaction, though, was relatively muted because the monthly labour force data is recognized to be volatile, job creation over the last 12 months has been robust notwithstanding the recent losses, and growth in average hourly earnings remained strong at 4.4% in the last year. Additional negative news included manufacturing sales, wholesale trade, and retail sales during October that were reported much weaker than expected. Those contributed to Canadian GDP declining slightly in the month, suggesting overall fourth quarter growth may be slower than previously forecast. However, inflation accelerated to 2.2% from 1.9%, and the average of the Bank of Canada’s three core measures of inflation also rose to 2.2% from 2.1% the previous month. The generally weak data in December did not have a lasting impact on Canadian bonds as, instead, they followed the global trend to higher yields with the reduction in U.S./China trade tensions.

The Bank of Canada left its administered rates unchanged at its rate setting meeting early in the month. Subsequent speeches by Bank officials indicated that the spate of weak data was believed to be transitory and was not going to lead to interest rate reductions in the near term. While the Bank might react if growth slows significantly more, the high level of household indebtedness and above-target inflation argue against lower rates at this time.

U.S. economic data was somewhat mixed but, on balance, positive. Very strong job creation led to a drop in the unemployment rate to 3.5% from 3.6% a month earlier. Housing starts rose to the second highest level since before the financial crisis and an increase in building permits suggest further growth in starts in the coming months. As well, industrial production in November experienced a better than expected rebound following the end of the GM strike and business investment spending rose sharply. Less positively, retail spending and business sentiment surveys were weaker than forecasted. Inflation jumped to 2.1% from 1.8%, and core inflation measures remained above target at 2.3%. The Federal Reserve left its trendsetting interest rates unchanged in December and indicated that it would keep rates steady for several months while it evaluates the impact of the three rate reductions earlier in the year.

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