Financial market volatility continued in February led by a sharp decline and then a rebound in the price of oil. Equity markets tracked oil prices fairly closely, albeit with more muted moves. Oil plunged 22.5% from the end of January to February 11th, hitting an intra-day low of $26.05 per barrel. However, news that Saudi Arabia, a few other OPEC members, and Russia were considering capping their oil production at the levels attained in January prompted a strong recovery in oil prices that left them up 0.4% over the whole month. The S&P/TSX, the S&P 500, and the Morgan Stanley World Composite all fell between 6.5% and 7% as oil dropped. Once oil started rebounding, so too did equity markets as they finished the month with only small gains or losses. The safe haven characteristic of bonds was evident in February; bond prices rose and yields fell as oil and stocks plummeted, with some benchmark Canada Bond yields hitting all-time record lows. Once oil and stocks started to recover, bonds lost their glitter, their prices fell and yields rose. The FTSE TMX Canada Bond Universe returned a meagre 0.21% in the month, belying the volatility during the period.

Canadian economic data contained both negative and positive news. Unemployment edged higher to 7.2% from 7.1%, as job growth stalled. Retail sales in December were also weak, following a strong performance in November. More positively, the trade deficit was considerably smaller than expected in the most recent month because exports grew faster than imports. (For all of 2015, the trade deficit was $23.3 billion, much larger than the previous record of $13.3 billion in 2012 and the $4.8 billion surplus on 2014.) An improved trade balance, if it persists, would result in substantially better GDP growth. Indeed, as this is being written, Canadian GDP for both December and the fourth quarter of last year were reported to be better than expected but still below potential. On balance, the data showed that the Canadian economy was struggling, but clearly not in a serious recession as discounted in some financial markets. Of concern, though, was the rise in inflation to 2.0% from 1.6% due to increasing food and transportation costs.

Notwithstanding the risk-off near-panic in global markets to start February, U.S. economic news was generally positive. The unemployment rate fell to 4.9%, the lowest since the start of the financial crisis eight years ago. While U.S. job creation was a little disappointing in the most recent month, other labour market measures including average hourly earnings, the length of the work week, and the participation rate showed continued improvement. As well, the number of job openings was the second highest on records going back to 2000. A number of other economic indicators also exceeded expectations including fourth quarter GDP, personal income and spending, retail sales, industrial production, and vehicle sales. Less positively, construction spending was weaker than expected and consumer sentiment fell as a result of the volatility in stock markets. As in Canada, inflation accelerated in the U.S., rising to 1.4% from 0.7% a month earlier.

Sweden’s central bank, the Riksbank, surprised observers by lowering its administered interest rates further into negative territory in February, moving from -0.35% to -0.50%. In spite of the Swedish economy growing at an enviable pace of almost 4% in the most recent quarter, the Riksbank was concerned that Swedish inflation was too low. The move helped ignite debate about the effectiveness of negative interest rates. A number of central banks globally have adopted negative rates citing several potential benefits. Some of these include lowering the real cost of borrowing to encourage borrowing and improve economic activity, to discourage banks from holding excess cash at the central bank, to devalue the currency, and to encourage purchases of riskier assets such as equities. Critics of negative rates note that household and business borrowing in countries with negative rates has not increased meaningfully, nor has inflation. In addition, negative rates have decreased profitability of banks at a time of growing loan losses, and equity markets have been falling with considerable volatility. Another criticism of negative interest rates is that they may be interpreted as a pessimistic signal that dampens borrower confidence.

The Canadian yield curve flattened in February as short term bond yields rose and longer term yields declined. The yield on 2-year Canada bonds rose 10 basis points to 0.52%, as investors discounted the likelihood of another interest rate reduction from the Bank of Canada. The Bank appears to prefer to evaluate the fiscal stimulus promised in the upcoming federal budget before considering further rate cuts. Yields on 30-year Canada Bonds closed 6 basis points lower, having been down 21 basis points mid-month, as not all of the flight-to-safety bid reversed by month end. Canadian long bond yields were also influenced by U.S. bond yields; 30-year Treasury Bond yields declined 13 basis points in the month.

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