Following the outsized gains of January, the Canadian bond market consolidated in February. Bond prices initially moved higher, pushing yields to all-time record lows. However, prices subsequently fell and yields edged higher. Economic data was mixed, although slightly positive on balance. Central bankers, including the U.S. Federal Reserve, gave mixed messages, and the Bank of Canada, in particular, executed a monetary policy flip-flop. Factors which have had substantial impacts on bond markets in recent months appeared to stabilize in the month. Oil prices, for example, were little changed and the European debt crisis did not worsen. The FTSE TMX Canada Bond Universe returned -0.13% in the period.

In Canada, unemployment eased to 6.6% from 6.7%, but the details of the jobs data were less positive as the number of fulltime positions fell, while lower-paying part time jobs increased. Manufacturing sales and wholesale trade were stronger than forecasts, but retail sales were below expectations. The drop in retail sales reflected lower gasoline prices, but sales of clothing and electronics were also sharply lower. The Canadian trade deficit was smaller than expected as higher precious and base metals exports helped offset the declining value of energy exports. Housing starts were better than expected, but remained within their recent range. Inflation fell less than expected, dropping to 1.0% from 1.5%. Core inflation, which is thought to be a better indicator of underlying inflationary pressures, remained at 2.2%. The Canadian dollar traded in a fairly narrow range around US$0.80 during the month.

Following its January 21st surprise interest rate reduction, the Bank of Canada gave every indication that it would reduce rates again, likely as soon as its March 4th meeting. Oil prices had moved well below the Bank’s US$60 per barrel assumption, and Bank officials spoke of the need to offset the negative impact on the Canadian economy. Bond yields fell sharply as investors anticipated further rate cuts. Yields of 2 and 5-year Canada bonds fell to 0.40% and 0.60%, respectively, well below the Bank’s 0.75% overnight target rate. Investors clearly expected the Bank to move rates lower. On February 24th, however, Bank Governor Stephen Poloz indicated a change of course, suggesting that the one rate reduction might have been sufficient. Investors began discounting the likelihood of a March 4th rate cut, pushing bond prices lower and yields higher. [As this is being written, the Bank of Canada has announced on March 4th that it would leave rates unchanged.] The flip-flop undermined the markets’ confidence in the Bank’s ability to interpret the economic data and created uncertainty around the Bank’s policy. Unfortunately, this took the focus away from fundamentals and instead put it on the Bank’s semantics.

Economic news in the United States was generally favourable. The labour situation, in particular, showed considerable strength: job creation was very robust and the number of unfilled job openings hit a 14-year high. Unemployment did rise to 5.7% from 5.6%, but only because the participation rate increased as previously discouraged workers returned to the labour force. Not surprisingly, personal income was stronger than forecasts, although spending was weaker than expected. Retail sales failed to meet expectations, due to lower gasoline prices and weaker automobile sales. Weaker energy prices

The price of oil moved modestly higher in February. Having traded in a range around US$46/barrel for much of January, West Texas Intermediate (WTI) traded close to US$50/barrel in February. With many producers estimated to have significantly higher costs, it would make sense that the price of oil to stabilize in the next few months before moving higher. Should that transpire, global inflation would start to recover and fears of more general deflation would likely recede.
were the main reason that U.S. CPI fell to -0.1% from 0.8% the previous month. The inflation news, though, was for the month of January, and in February gasoline prices rebounded by 20% from their lows the previous month. As a consequence, inflation was expected to rebound in the coming months. The low current inflation rate did alleviate any immediate pressure on the Fed to raise interest rates. As a result, Fed speakers tended to be somewhat dovish, although leaving open the door to a rate increase in June.

U.S. gasoline prices have rebounded 20% from their January lows.

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