A second development was the announcement by the European Central Bank (ECB) of a long-anticipated quantitative easing programme. The objective was to stimulate economic growth and lower the risk of deflation by buying bonds and reducing long term yields. The size of the total monthly purchases at €60 billion was somewhat larger than market expectations and, as a consequence, pushed already low European bond yields even lower. At least 9 countries in Europe (viz. Germany, France, Netherlands, Belgium, Austria, Switzerland, Finland, Denmark, and Sweden) had some of their bonds producing negative yields in January. Negative yields mean, of course, a guaranteed loss, which raises the question why investors would accept that? One possible explanation is that investors may be trying to protect their capital and do not trust banks sufficiently to deposit their funds with them. The ongoing Greek debt crisis could result in crippling losses at some banks, which investors wanted to avoid. A second explanation for negative yields is that investors are anticipating deflation that would turn negative nominal yields into real positive ones. A third explanation is that investors are anticipating foreign exchange gains that will outweigh the negative yield. Investors in Swiss bonds certainly experienced that. Another possible reason is that investors were speculating that they would be able to resell the bonds at even higher prices (and more negative yields) to the ECB once the quantitative easing programme begins in March.

A third noteworthy European development was the Greek election that was won by the anti-austerity party, Syriza. That should result in protracted, headline-grabbing negotiations about restructuring and/or reducing Greece’s debt. It raised the potential for Greece to leave the European Union (an event nicknamed Grexit) and potentially cause another financial crisis. Thus, the election contributed to the flight-to-safety bid for bonds in January.

As noted above, Canadian bond yields fell sharply in January. Yields on 2 and 5-year Canada bonds dropped 62 and 73 basis points, respectively. Yields of 10 and 30-year Canada bonds fell 65 and 50basis points, respectively. The drop in shorter term bond yields was partially due to investor sentiment that the Bank of Canada was likely to cut interest rates again at either its March 4th or April 15th rate setting meetings. The flight to safety bid also played a part in the large decline in yields, as the yields of U.S. Treasury bonds maturing in 10 and 30 years fell over 50 basis points in the month.

The plunge in Canadian bond yields took them to record low levels in January. Whether the bonds mature in 2 years or 30 years, their yields have never been this low. As can be seen in the chart of 10-year Canada bond yields below, the yields are substantially below those hit during the 2008 financial crisis and lower than at any time in the last 70 years.

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Years

The federal sector earned 4.00% in January, with bond prices rising as yields dropped. The provincial sector, which has longer durations on average and thus benefits more as yields decline, returned 6.27%. Corporate bond returns trailed those of government bonds, because yield spreads widened slightly as investors became more pessimistic about future economic prospects. New issue corporate supply was quite light in January as many issuers turned to the U.S. and European bond markets for cheaper financing. Non-investment grade bonds continued to struggle, both because of the preponderance of energy-related issuers and because high yield issuers have less ability to withstand slowing economic activity. High yield issues earned only 0.08% in the month. Real Return Bonds returned 9.03%, as the monthly decline in CPI had largely been anticipated.

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