In Ottawa, the federal government unveiled its budget for the next fiscal year and chose to spend the gains from stronger than expected economic growth in 2017 rather than reducing its deficit. In conjunction with the budget, the government also updated its Debt Management Strategy, a document that outlines the government’s plans for financing itself. Gross issuance of federal bonds will drop from $138 billion in the current fiscal year to $115 billion, and net issuance (i.e. gross issuance less maturities) will fall from $43 billion to $20 billion. The reduced bond issuance will be offset by higher amounts of Treasury Bills. Most of the reductions in issuance will be at the 2 and 3-year maturities, which should lessen the potentially positive impact on longer term yields.

U.S. economic data continued to show that that economy was operating at full capacity. While some indicators, such as retail sales and monthly manufacturing production were weaker than expected, most indicators were stronger than their respective forecasts. Business and consumer sentiment surveys were more positive than expected, housing starts exceeded the most bullish forecast, and inflation was higher than predicted. At the beginning of the month, Janet Yellen was replaced by Jerome Powell as the Chair of the Federal Reserve Board, the U.S. central bank. No shift in the Fed’s policies are expected as a result of the changeover.

As noted above, bond yields initially rose and subsequently fell during February. For the month as a whole, yields of 2 to 10-year Canada bonds declined 5 to 8 basis points, while long term yields were unchanged. The shift in Canadian yields was in marked contrast with U.S. bond yields during the month. U.S. Treasury yields rose between 12 basis points (2-year bonds) and 19 basis points (30-year bonds). As a result, Canadian yields of all maturities moved roughly 20 basis points further below U.S. equivalents during the month.

The decline in short and mid term bond yields helped propel the federal sector to a return of 0.36% in February. The provincial sector earned only 0.04%, because provincial yield spreads widened in the month and because more provincial issues were long term ones and did not benefit from a decline in yields. Corporate bonds returned a meagre 0.02% in the period, as their yield spreads widened an average 6 basis points in February. Equity market volatility apparently affected some investors’ evaluation of creditworthiness. There were $6.8 billion of new, fixed rate corporate issues in the month, plus $1.5 billion of new floating rate issues. Non-investment grade corporate bonds were also impacted by the volatility of equities, declining -0.20% in the month. Real Return Bonds earned 0.31%, as the higher than expected inflation data increased demand for RRB’s. Preferred shares were the laggards in the month, declining -1.05%.

Both the Bank of Canada and the Fed will hold rate-setting meetings in March. The Fed is widely expected to raise its interest rates by 25 basis points on March 21st, as it tries to normalize monetary policy with the U.S. economy at full employment. The Bank of Canada, which is scheduled to announce its decision on March 7th, is unlikely to raise its interest rates ahead of the Fed move. Instead, the Bank is more likely to act on April 18th, its next scheduled announcement date. The Bank’s action is not a certainty, however, and will be dependent on both better economic data and some resolution of trade concerns with the United States.

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