The Bank of Canada continued buying at least $5 billion of Government of Canada bonds in the secondary market on a weekly basis. In doing so, the Bank essentially offset all the federal government’s new issues in the month, which meant the rapidly expanding fiscal deficit did not result in higher yields. The Bank’s purchases of provincial and corporate bonds, though, were much more subdued. The Provincial Bond Purchase Programme bought a total $2.26 billion of short and mid term provincial bonds during June. And in its first full month of operation, the Bank’s Corporate Bond Purchase Programme (CBPP) purchased only $112 million of corporate bonds, much less than its potential $10 billion size over the next year. The average size of the purchases was roughly $2 million, suggesting the Bank was trying to clean up illiquid holdings from investment dealers’ balance sheets rather than move corporate yield spreads tighter. In addition, the Bank purchased only corporate bonds maturing in five years or less and avoided both mid and long term issues. However, with demand for credit remaining strong, the CBPP did help tighten corporate yield spreads in the month.

The Bank of Canada’s new Governor, Tiff Macklem, took over from Stephen Poloz in early June. As expected, there was little apparent change in the Bank’s policies or its programmes to counter the economic slowdown brought on by the pandemic. In particular, the Bank did not believe negative interest rates were a worthwhile monetary tool. However, Macklem acknowledged that the Bank’s large-scale purchases of federal bonds amounted to quantitative easing (QE), which Poloz had not. Macklem also indicated that the Bank might eventually consider yield curve control, a monetary strategy employed by some other central banks to keep mainly shorter term bond yields at specified (low) levels.
The rating agency, Fitch, downgraded Canada in June to AA+ from AAA due to the deterioration in public finances brought on by the pandemic. The three other major rating agencies, DBRS, Moody’s, and Standard & Poors, continued to rate Canada as AAA and did not give any indication they were considering a downgrade. However, given the massive fiscal stimulus provided by the federal government and the resultant budget deficit that is expected to exceed 10% of GDP, Canada is likely to see further ratings downgrades, as are most other countries. In the short term, though, the Fitch move had little discernable impact on Canadian bonds.

The Canadian yield curve flattened in June. Yields of short and intermediate term Canada bonds were little changed in the month, but 30-year yields finished 12 basis points lower. The decline in long term yields was due to a combination of factors. Demand for duration was elevated because index durations increased in early June. However, the supply of new long term bonds was relatively low and insufficient to meet demand. In addition, the severity of the economic downturn may have led some investors to expect that yields were likely to remain low for longer than previously anticipated. The rise in long term bond prices that led to falling yields was somewhat remarkable because Canada’s Finance Minister, Bill Morneau, suggested the federal government was considering extending the term of its debt as a result of its massive need for funding. The rally in 30-year Canada bonds was also in contrast with U.S. Treasuries that saw little change in yields at all maturities.

Federal bonds earned 0.50% in June, as short and mid term bond yields were little changed. The provincial sector returned 2.11% in the month. Over half of provincial bonds are long term in nature, so the decline in 30-year benchmark Canada bond yields was a significant factor in the strong performance of provincial bonds in the month. In addition, provincial yield spreads narrowed by an average of 4 basis points. Investment grade corporate bonds returned 2.57% in June as their yield spreads narrowed by a remarkable 29 basis points, with the U.S. Federal Reserve’s moves to tighten American corporate yield spreads the primary catalyst. Corporate issuers with both Canadian and U.S. dollar denominated debt initially experienced sharp contractions in USD spreads that subsequently forced CAD spreads to also narrow. New issue supply of $7.5 billion in the month was roughly half of year ago levels but followed two months of very robust issuance. High yield bonds returned 3.36% in June. Energy related high yield bonds fared particularly well because the price of oil rose 18% in the month. There were two new high yield deals in the period, one for Parkland and a very large issue for Air Canada. Real Return Bonds gained 2.40%, modestly outperforming nominal bonds, as investors worried that massive fiscal stimulus measures and ultra-low interest rates might eventually lead to higher inflation. Preferred shares performed well in the risk on environment during June, earning 3.92%.

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