In the United States, economic data was also generally stronger than expected. Most importantly, job creation surged to higher levels and previous months’ job data was revised upward. The Fed had identified the weak labour market as a principal reason to extend its extraordinary monetary stimulus, and the improved job situation led investors to reassess their expectations of when the Fed would begin tapering its bond purchases. Bond prices in the U.S. and Canada fell to their lowest levels of the month following the release of the labour data.

The Canadian yield curve steepened in November, mirroring a similar shift in the U.S. yield curve. Yields on 2-year Canada bonds fell slightly, as the low inflation data was thought likely to make the Bank of Canada more dovish, with some observers speculating about interest rate reductions. In contrast, 10 and 30-year yields rose roughly 14 basis points as they tracked a similar increase in U.S. Treasury yields. With yields of most Canadian bonds going up in the month, bond prices fell, and the federal sector returned -0.26%. Provincial bonds, which are mostly longer term, returned -0.47% in the month even though yield spreads narrowed 3 basis points on average. The corporate sector earned 0.01%, as tighter long term corporate bond spreads helped offset higher benchmark yields. New issue supply was robust at $12.8 billion, bringing the year-to-date total to a record $105.6 billion. Real Return Bonds fell 2.55% in the month, as their long durations meant greater price movements as yields rose and the lower CPI data reduced demand.

Canadian bond investors have been taking their lead from developments in the U.S. bond market, and we do not anticipate that that will change in the near term. Barring an unsuspected crisis such as a stock market crash or a sovereign credit default, the Canadian bond market appears to be in a trading range until there is greater clarity about the Fed’s tapering plans. The Fed next meets in mid-December, and could announce plans to reduce its bond purchases at that time. However, we believe the Fed will probably defer that decision until early next year in order to have greater confidence about the strength of the U.S. economy.

With trading activity usually winding down for the holidays, liquidity typically diminishes in December leading to the potential for increased volatility. A very large ($5 billion), long term financing for the Labrador hydroelectric development, Muskrat Falls, and the ancillary transmission lines may come to market in December and could cause some fluctuations in the market. We would expect the impact to be temporary, however.

Strategically, we will look for opportunities to adjust duration as the market moves within the trading range. With regard to the yield curve, following the rally in very short term bonds, 4 and 5 year bonds are offering better value than 2 and 3 year bonds, and we continue to shift holdings to take advantage of that. As well, cash levels have been substantially reduced. Corporates remain our preferred sector as creditworthiness is good and yield spreads are acceptable. However, should yield spreads narrow much further, we will look to take some profits and reduce the corporate allocation.

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