As widely expected, the Fed lowered its administered interest rates by 25 basis points on July 31st. The Fed acknowledged that economic activity was growing at a moderate pace with unemployment low and job creation solid. However, the central bank was concerned about slowing global economic growth and inflation that was persistently below its 2% target. The Fed also ended the runoff of its bond holdings two months earlier than planned. Fed Chairman Jerome Powell described the move as a mid-cycle adjustment, rather than the start of a long easing cycle. The rate cut was intended to provide insurance from the potential, future negative impact of the ongoing trade disputes. The Fed’s July 31st statement left the door open for another rate cut at its next meeting in September, but the dissention of two voting members to the July move suggest that a second reduction is not a certainty. Investors who had anticipated a series of rate cuts that would have steepened the yield curve reacted by selling short and mid term issues and buying longer term bonds leading to a flattening of the yield curve.

In Europe, the economy expanded just 0.2% in the second quarter, down from the 0.4% rate in the first three months of the year. At its July 25th meeting, the European Central Bank indicated that it was concerned about growing downside risks to growth and it was looking at potential ways to provide additional monetary stimulus. European bond yields declined in the month, many to record negative low levels, which spurred interest in Canadian bonds which continued to have positive yields. In Great Britain, Boris Johnson became Prime Minister. That led to a sharp decline in the value of the pound because Johnson appeared to support a no-deal Brexit, which many feared would cause economic chaos in Britain.

The Canadian yield curve flattened in July as short term bond yields rose more than long term yields in the aftermath of the Fed’s rate reduction. Yields of 2-year Canada bonds climbed 8 basis points in the month, while 30-year yields edged only one basis point higher. The shift in the U.S. yield curve was slightly more pronounced, with 2-year U.S. Treasury bond yields up 14 basis points and 30-year yields 3 basis points higher. The fact that bond yields actually rose in a month which had the first Fed rate cut in a decade indicated how well anticipated the Fed’s move was.

Federal bonds returned -0.09% in July as higher yields pushed bond prices lower. The provincial sector returned +0.22% as the sector’s yield spreads tightened by 2 basis points on average in the month. Investment grade corporate bonds earned +0.42% in the month. Corporate yield spreads narrowed an average 4 basis points, with mid and long term spreads enjoying the best performance. As usually occurs in summer months, new issue supply declined, with only $6.1 billion on new, fixed rate deals in July. Of that, three large bank issues accounted for $4.25 billion, or 69%, of the total. High yield bonds gained 1.20% in the period, markedly outperforming investment grade issues. Real Return Bonds earned +0.45% in the month, outperforming long term, nominal Canada bonds with similar durations. Preferred shares enjoyed a second consecutive month of good gains, earning 1.31% in the month.

As this is being written, U.S. president Trump has announced that the U.S. will impose 10% tariffs on the remaining $300 billion of Chinese imports that are not yet subjected to tariffs starting on September 1st. The surprise announcement sparked a sharp flight-to-safety rally in global bonds because investors feared more tariffs would slow global growth even more. U.S. bond yields have seen the largest declines, with yields of short and mid term U.S. Treasuries falling more than 15 basis points. Other bond markets, including Canada’s, have seen yield declines of as much as 5 to 10 basis points.

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