Federal bonds returned 0.22% in the month. Provincial issues earned 0.46%, as their longer average terms to maturity meant lower yields that offset a small widening in provincial yield spreads. Investment grade corporate bonds returned -0.10%, with yield spreads again moving wider. During the particularly volatile first half of the month, new issuance was quite light. With the second half recovery in risk sentiment investors became more receptive to new issues and issuance picked up. For February as a whole there were $7.6 billion of new corporate issues. New issue concessions of 20 to 25 basis points were common, and new issues tended to reprice existing issues to wider spreads. However, later in the month it appeared that new issues were tightening somewhat toward existing issues, which suggested that the corporate bond market might be starting to stabilize. High yield bonds returned -0.06%, with energy issues the best performers as they responded to the rebound in oil prices with a relief rally. Real Return Bonds gained 0.36% in the period. Preferred shares declined -3.64% in February.

Over the last year or so, many investors have used the price of oil as their primary indicator of global demand and economic growth. While we would argue that the collapse in oil has been due to over-supply compounded by geopolitical posturing rather than a shortfall in demand, it was a relief to see the rebound in oil prices in the second half of February. News that four major oil-producing countries had agreed to cap their production at their respective January rates reminded us of Winston Churchill’s comment following the battle of El Alamein: “Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.” We expect negotiations to limit oil production and raise the price somewhat will continue for a few months before they are successful. However, the push to lower prices to punish high cost producers may finally be over.

If we are correct that we have indeed seen the cyclical bottom in oil prices, we believe that risk sentiment will improve across various markets. The pace of the improvement may, however, be halting and uneven. Within the bond market, corporate and provincial yield spreads have been oversold due to excessive pessimism about the economic outlook. Outside of the energy sector, economic growth remains positive, albeit below potential. Most economists and policymakers agree that we are not in the serious recession that markets have been discounting. Prior to a G-20 meeting in late February, U.S. Treasury Secretary Jacob Lew gave an apt comment about the group’s potential reaction to recent global market turbulence: “Don’t expect a crisis response in a non-crisis environment.”

We are monitoring the bond market closely for confirmation that risk-off sentiment is abating. If that is in fact occurring we would expect federal bond yields to move somewhat higher over the next few months. Yield spreads of provincial and particularly corporate bonds have considerable potential to tighten. We are looking for indications that the corporate sector is stabilizing before we add to current holdings. One of the indications will be whether new issues stop repricing existing ones. When that happens, we will increase the corporate allocations. The performance of the recent TD NVCC bond subsequent to its new issue has been encouraging, because its yield spread has tightened by almost all of its new issue concession.

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