The Canadian bond market eked out a tiny gain for the second straight month. Bond prices moved lower as yields edged higher, but interest income was just sufficient to offset the drop in prices. Volatility was lower than in recent months as the United States continued to try to reshape global trade, but with fewer headlines. Investors and both the Bank of Canada and the U.S. Federal Reserve waited to see how those efforts would turn out. Geopolitical risk increased when Israel attacked Iran’s nuclear facilities, with the United States eventually joining in the attacks, but there was little lasting impact on the bond market. The FTSE Canada Universe index returned 0.06% in the month.

Much of the Canadian economic data received in June covered activity in April and showed the economy weakening but not precipitously as the U.S. trade war began. Canadian GDP declined 0.1% in April due to weak manufacturing activity, but the estimate for March GDP was revised higher to +0.2%. There was also a record trade deficit in April as exports fell 10.8% due to U.S. demand for Canadian goods plunging due to the tariffs. The decline in exports was also exacerbated by the high levels of exports experienced earlier in the year as people tried to front run the tariffs. The unemployment rate rose to 7.0% in May from 6.9%, but job creation was better than expected despite the unwind of significant election hiring in April. Inflation was higher than forecast, remaining at 1.7%, but the core rates of inflation declined slightly to 3.0%. The Bank of Canada chose to leave its benchmark interest rate at 2.75% as it wanted more clarity on the impacts of the trade war.

Last month, we noted the discrepancy in the United States between soft data that looks at sentiment and opinions and hard data that measures actual activity. In June, the discrepancy was diminished as some of the hard data weakened. Examples included weaker than expected retail sales, declining factory orders, and weaker than expected housing starts because of high mortgage rates. Other indicators, though, showed resilience in the U.S. economy including the unemployment rate holding steady at the historically low rate of 4.2%. Inflation edged up to 2.4% compared to 2.3% the previous month, but there was not the significant tariff bump that some economists had feared. Despite frequent calls from the Trump administration for a rate cut, the Fed left its interest rates unchanged in June.

Internationally, the trend to lower interest rates continued in June. The European Central Bank lowered its interest rates by 25 basis points, its seventh consecutive rate cut. However, despite the ECB’s rate reduction, most European government bond yields rose in June. As well, Norway’s Norges Bank and Sweden’s Riksbank made similar 25 basis point reductions in their respective rates. Swiss National Bank also lowered its interest rates by 25 basis points, in this case an effort to slow the appreciation of the Swiss Franc, which has been one of the strongest performing currencies this year. The SNB’s move took its rate to 0.00%, leading to speculation that it would be the first central bank to return to negative interest rates.

The Canadian yield curve steepened somewhat in June. The yield of 2-year Canada bonds edged higher by a basis point while yields of 30-year Canadas rose 9 basis points. The move to higher Canadian yields was in contrast to the U.S. bond market which experienced a drop in yields. The yields of 2-year and 20-year Treasuries declined 16 basis points, while 5-year and 10-year Treasury yields fell 20 basis points in the month. The somewhat weaker economic data, as well as a lack of inflationary impact so far from the tariffs, led U.S. investors to anticipate rate cuts by the Fed later this year. The massive increase in future fiscal deficits from the proposed budget and policy bill working its way through Congress was mostly ignored.

The federal sector of the Canadian bond market returned -0.03% in June as higher yields caused bond price declines that were not quite offset by interest income. The provincial sector returned 0.00% as a 7 basis point narrowing of long term provincial yield spreads helped counter the impact of higher benchmark Canada yields. The investment grade corporate sector earned 0.29% as strong investor demand caused yield spreads to narrow an average of 6 basis points. The tighter yield spreads was remarkable because new issue supply of just under $20 billion was the third highest monthly total on record. A tender by Telus for $1.4 billion of its low coupon long term bonds helped offset the surge of new issues. Non-investment grade bonds, which are often correlated with equities, performed well in the period gaining 1.02%. Real Return Bonds returned -0.58%, hurt by their relatively long durations as nominal yields rose. Preferred shares extended their rebound from April’s tariff-induced selloff, earning 2.77% in June.

One of our favorite economists, Doug Porter of BMO, recently pointed out that financial markets are performing differently in 2025 than they have in the past. Among the differences he noted was that the U.S. dollar weakened rather than strengthening following the attacks on Iran. In the past, the U.S. dollar has been viewed as a safe haven in times of uncertainty, but if it loses that attraction, it suggests U.S. rates may need to stay higher to attract foreign investors. Doug also noted the recent equity market reaction. Notwithstanding the wild swings in trade policies, geopolitical turmoil, and U.S. budget uncertainty, U.S. and Canadian equity markets have been hitting record highs. That risk tolerance appears to have convinced bond investors to push corporate spreads to the tightest levels since the Great Financial Crisis of 2008. Bond investors also appear to be ignoring the massive U.S. budget deficits and threats to the independence of the Fed. The unusual performance of various markets this year suggests these are very uncertain times and any forecast, including ours, must be taken with a grain of salt.

As the third quarter of the year begins, we are still waiting to assess the impact of the U.S. trade war. Early in April, U.S. president Trump initiated tariffs on virtually all U.S. imports but then delayed their implementation until July 9th to allow time for the U.S. to negotiate new trade agreements with all its trading partners. As that deadline approaches, few agreements have yet been concluded and the ones that have tend to be more framework than comprehensive in nature. We suspect the July 9th deadline will need to be extended. Canada’s negotiations with the U.S. have a slightly later deadline, July 21st. While details are scarce, it appears the Canadian government is trying for a comprehensive pact that will also deal with security and military spending.

As we noted in June, we do not see any likelihood that the Bank will raise interest rates over the balance of this year, the uncertain outcome of Trump’s threaten-and-postpone tariff antics mean future rate cuts are not a foregone conclusion, however. Over the next few months, we anticipate the uncertainty will continue to dampen economic activity in Canada, so we are comfortable maintaining somewhat longer than benchmark portfolio durations. We also believe that the recent tightening in corporate yield spreads means that they are not providing appropriate returns for the level of economic and financial risk. Accordingly, we are cautious about the corporate sector.

We note that one of the recent pressures on the Canadian economy, rapid population growth, has been alleviated. As recently as the third quarter of last year, Canada’s population had been growing by more than 3% per year. In the first quarter of this year, though, growth was only 0.8%, the slowest non-pandemic pace since 2015. If maintained, the slower pace will result in gradual improvements to housing affordability, rent costs, infrastructure pressures, and unemployment.