U.S. economic data during June continued to show that economy operating a full capacity. Unemployment declined from 3.9% to 3.8%, an 18-year low, and business and consumer sentiment remained very high. With little or no slack in the U.S. economy, it was not surprising that inflation accelerated to 2.8% from 2.5% the previous month. On June 12th, the U.S. Federal Reserve did the expected and increased its administered interest rates by 25 basis points. The accompanying statement, though, was somewhat more hawkish than anticipated because it suggested that two more rate increases may occur this year when the consensus had been for only one. In addition, Fed Chair Jay Powell indicated that the Fed would stop providing forward guidance on interest rates, a process that had been implemented when the Fed had cut rates close to zero and wanted to keep rate expectations low so as to stimulate the U.S. economy. With the economy now operating at full speed, the provision of guidance is not needed.

The day after the Fed raised its interest rates, the European Central Bank announced that it planned to end its purchases of bonds, known as quantitative easing (QE), later this year. If economic conditions remain favourable, in October the ECB will reduce its monthly purchases to €15 billion from the current level of €30 billion and stop the buying altogether after December. The impact of the prospective end of QE was offset by a commitment by the ECB’s president, Mario Draghi, to keep its interest rates at the current ultra-low levels until at least next summer. In the short run, the prospect of QE ending had negligible impact on the bond market, as investors focussed more on a possible trade war developing.

The Canadian yield curve flattened slightly in June. The yield of 2-year Canada bonds was little changed in the month as investors anticipated a rate increase by the Bank of Canada on July 11th. Yields of 10 and 30-year bonds, however, declined 6 basis points as investors discounted slower growth due to a possible trade war. The yields of 30-year bonds also declined due to demand for duration from a few large pension funds and life insurance companies trying to match their liabilities. New issue supply of long term issues, particularly from federal and provincial governments, was insufficient to meet demand.

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