In late December, reduced liquidity contributed to Canadian bond prices moving sharply higher. In the first few days of this year, those gains were quickly reversed as bond prices moved back down to the levels of mid-December. Subsequent economic data reinforced the view that the recovery was accelerating from the summer doldrums. That information led to further declines in bond prices and increases in yields. However, late in the month, political and civil turmoil in Tunisia, Egypt, and other Arab countries caused a flight to safety bid for bonds, and they regained some of their earlier declines. The DEX Universe Bond index declined 0.44% in January.

In Canada, the unemployment rate held steady at 7.6%, but job creation was good at 22,000 new jobs. Importantly, part time jobs were replaced in significant numbers by full time positions, which generally implies higher incomes. Business activity picked up steam as wholesale sales grew 1.2% versus the previous month, with widespread gains outside of the auto sector. (The auto sector experienced a slowdown that was likely temporary given increasing demand in the United States.) The consumer sector also showed strong growth in retail sales. The strength in the business and consumer sectors was reflected in Canada’s gross domestic product, which in November increased at the fastest pace in eight months. In addition, Canadian leading indicators continued to point to accelerating growth.

Notwithstanding the improving economic environment, the Bank of Canada left its trendsetting interest rate unchanged at its January 18th meeting. Although the Bank acknowledged that global economic growth was faster than it expected, it indicated that it was concerned about the strengthening Canadian exchange rate and the resultant headwinds for Canadian exporters. Given the risk that additional rate increases would cause the Loonie to appreciate further, many observers interpreted the Bank’s comments to mean that it would be slower to raise rates than previously expected.

In the United States, industrial production grew by 0.8% in December, and was up 5.9% over the past year. As a result, capacity utilization climbed to 76.0%, well above the June 2009 low of 68.2% but still 4.6% below its long term average. The pace of growth in U.S. gross domestic product was estimated to have been 3.2% in the final quarter of 2010, up from 2.6% in the previous quarter. The improvement was driven by the largest gain in consumer spending in over four years and increasing exports. In addition, a large reduction in inventories significantly depressed the GDP growth rate; without declining stockpiles, GDP would have grown at a remarkable 7.1% pace. The decline in inventories during the fourth quarter bodes well for growth in early 2011 as businesses work to rebuild them. Indeed, recent surveys of manufacturers show a substantial increase in orders, which will necessitate increased production. The unemployment rate fell to 9.4% from 9.8%, but most of the improvement was due to falling participation rather than more jobs. Although still low, consumer confidence improved somewhat, and that was reflected in higher auto sales. Car and light truck sales have grown steadily since the recession lows of 2009, but remain well below their pre-crisis levels. Less positively, the housing sector failed to show any substantive improvement, weighed down by foreclosures and concerns about job security. Of particular concern, U.S. housing prices have started falling again, albeit at a subdued pace.

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