As noted above, there was an absence of headlines regarding the European debt crisis. For now, the politicians appear to have stabilized the situation, although plans to achieve sustainable growth remain elusive. There was some positive news on the European banking sector, however. In 2011, many European banks were having financing difficulties because of concerns about their potential loan losses. In response, the European Long Term Refinancing Operation (LTRO) was set up by the European Central Bank to provide long term funding. In late 2011 and early 2012, 523 banks borrowed slightly more than €1 trillion under the LTRO. Last month was the first opportunity for those loans to be repaid and a total of 278 banks chose to repay €137 billion. That was much more than anticipated and reflected the desire of the banks to remove the stigma of having to borrow from the ECB.  The bigger-than-expected repayment underpinned risk appetite across financial markets, because it indicated funding conditions in the euro zone’s banking sector had improved. The stability of the region’s banks has been a key fear throughout the region’s long-running debt crisis. However, the challenges in the European banking sector are not by any means fully resolved. Only stronger banks were able to repay their LTRO loans, and there remain plenty of weaker banks with high levels of non-performing loans. Bottom line for Canadian bond investors: the safe haven bid for Canadian bonds was only slightly diminished.

Elsewhere in the globe, Chinese data indicated that the world’s second largest economy had stabilized and might be accelerating. If that trend continues, it would be positive for global growth and for Canada’s commodity exporters, in particular.

In Japan, the recently elected Prime Minister, Shinzo Abe, repeatedly put pressure on the Bank of Japan to accept responsibility for the country’s inflation target. Specifically, Mr. Abe wanted the Bank of Japan to take steps to ensure that, in the future, Japan had inflation averaging 2%, in contrast with the repeated bouts of deflation that it has endured in recent years. The prospect of additional Japanese monetary stimulus and higher inflation in that country led to a sharp selloff in the value of the Yen. That development raised concerns from a number of Japan’s trading partners that it was deliberately devaluing its currency in order to stimulate growth and reduce its trade deficit.Japanese Exchange Rate (Yen/US dollar) These concerns were heightened by comments from Japanese politicians suggesting even more Yen weakness was warranted. However, should the Yen weaken further, it is possible that some of Japan’s trading partners will try to implement offsetting devaluations of their own. Competitive devaluations, sometimes called a currency war, have in the past resulted in significant market volatility and weaker economic growth. Accordingly, we will be monitoring this situation closely.

Canadian yields rose across all maturities, but the largest increases were in longer term bonds. Yields on 2-year Canada bonds, for example, rose only 2 basis points, while 30-year Canada yields jumped 20 basis points. The steepening of the Canadian yield curve, which was similar to what occurred in the United States and other bond markets, reflected the central bank’s commitment to keep short term interest rates low for a protracted period. Short term yields were anchored by the Bank of Canada’s low rate policy, but long term issues had no such support. As noted above, the changes in Canadian yields were somewhat muted compared with the movement in other countries’ yields. Using 10-year benchmarks as examples, yields on Canada’s rose 19 basis points, while U.S. Treasury yields rose 23 basis points, U.K. Gilts gained 22 basis points, and German Bunds jumped 40 basis points.

The federal sector returned -0.74% in January as yields rose. The provincial sector fell 1.20% in the month, as their longer average duration resulted in larger price declines that more than offset the narrowing of provincial yield spreads by an average of 3 basis points. Corporate bonds were the top performing sector, returning -0.25%. Demand for corporates remained robust; even with $7.3 billion of new issues, corporate yield spreads narrowed an average of 6 basis points. The corporate sector also shrugged off the news that Moody’s was downgrading the big six Canadian banks. The Moody’s announcement had little impact because it had been expected and because the downgrades merely brought Moody’s ratings in line with those of the other rating agencies.

1 2 3