The Bank of Canada finally provided more details on its Corporate Bond Purchase Programme (CBPP). Bonds eligible for purchase had to have been issued prior to the April 15th announcement date, have less than five years remaining to maturity, and have at least one rating on April 15th of BBB(mid) or higher. If the issue was subsequently downgraded but retained at least one rating of BBB(low), it would still be eligible for the CBPP. The list of eligible issuers was larger than initially thought, primarily because it included the Canadian finance subsidiaries of foreign auto makers and was estimated to include approximately $116 billion of bonds (up from $80 billion). The list quickly shrank, however, as DBRS removed Ford Credit Canada’s last remaining investment grade rating, downgrading its $5.25 billion of bonds two notches to BB(high). The CBPP may buy up to $10 billion of corporate bonds over the next year. In contrast, the Bank of Canada’s Provincial Bond Purchase Programme (PBPP) will buy up to $50 billion of provincial bonds with maturities of ten years or less. The allocation between provinces will be determined by a combination of the provincial share of Canadian GDP and the proportion of provincial bonds outstanding.

The CBPP began operating in the final week of May. In two auctions, it could have purchased up to $200 million of bonds, selecting from a list of 111 securities. As it happened, the bank bought only 4 different bonds for a total of $21.5 million, surprising many observers with its lack of aggressiveness. However, the CBPP has already been very successful in causing a sharp narrowing of corporate yield spreads since the Bank announced it in mid-April. That result is very similar to the narrowing of U.S. corporate yield spreads following the Fed’s April announcement that it would be purchasing both investment and non-investment grade issues. The Fed’s purchases so far have been modest, but the impact of narrower spreads has been very significant.

The Canadian yield curve edged marginally lower in May with yields of most Canada bonds declining by only a single basis point. In the United States, the yield curve steepened; shorter term Treasury yields were slightly lower but longer term yields rose. The yield of 30-year Treasuries experienced the largest change, rising 13 basis points in the period.

Federal bonds earned 0.21% in May, with coupon interest the main source of returns as yields were only marginally lower. The provincial sector returned 0.22% in the month. Short and mid term provincial yield spreads narrowed a few basis points as a result of the Bank of Canada’s PBPP, but long term yield spreads widened slightly as a result ongoing issuance by the provinces. Investment grade corporate bonds gained 0.60% during May. As with provincial bonds, shorter term yield spreads narrowed while long term spreads widened marginally. However, with roughly half of all corporate bonds maturing in under five years, the average corporate yield spread narrowed by 5 basis points in the month, which resulted in better price performance. New issue supply was again robust with $17.75 billion raised, including several deals of $1 billion or more. High yield bonds returned 1.47% in May. Energy issues were particularly strong with oil prices rebounding 88% in the month. Real Return Bonds gained 0.16%, close to the return of nominal bonds, as investors worried that the recently announced massive fiscal stimulus measures might eventually lead to higher inflation. Preferred shares diverged from the rallying trend of other so-called risky assets and declined 1.72% in the month.

As noted last month, seasonal flows and index changes in early and mid June may have a significant positive impact on Canadian bonds. Approximately $68 billion of coupons and maturities will need to be reinvested in June, much of it coming on June 1st and 2nd. In addition, the Universe Bond index duration will extend an unusually large 0.22 of a year because June 2021 bonds will no longer qualify for the index. Notwithstanding the lack of direct correlation of the indices with their liabilities, many investors will adjust their portfolios to reflect the duration increases, thereby putting upward pressure on bond prices.

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