North American bond markets during November were focussed on the possibility that the U.S. central bank, the Federal Reserve, would begin raising interest rates at its next meeting on December 16th. With several Fed speakers, including its Chair, Janet Yellen, hinting that the first rate increase in a decade might come in December, investors evaluated each successive bit of economic data as either increasing or decreasing the likelihood of the Fed acting the following month. As it happened, data received early in November tended to be positive, which caused bond yields to rise and prices to decline. Over the balance of the month, though, the economic news was somewhat disappointing and bonds recovered most or all of their earlier losses. Canadian bonds generally followed the direction of their U.S. counterparts, but in a more muted fashion. The FTSE TMX Canada Universe Bond index returned 0.10% in the month.

In November, Canadian economic data was mixed, pointing to a continuation of below potential growth in this country. Unemployment declined to 7.0% from 7.1% a month earlier, but the improvement was primarily due to a surge in temporary part time jobs related to the federal election rather than permanent full time positions. Less positively, retail sales were weaker than expected and manufacturing sales fell sharply. CPI inflation was unchanged at 1.0%.

In the United States, economic indicators in early November were generally better than forecasts. The labour market strengthened, with unemployment falling to 5.0% from 5.1% on robust job creation, better than expected growth in average hourly earnings, and the second highest number of job openings since 2000. Vehicle sales remained above the 18 million annual pace for the second consecutive month, the strongest back to back performance in 15 years. Construction spending was also higher than expected, led by residential building. The positive news led investors to believe that the Fed was more certain to raise rates in December, which pushed bond yields higher. However, subsequent economic news was more negative and most bonds reversed course. Retail sales were weaker than anticipated and consumer confidence plunged. Housing starts were weaker than forecasts, as were manufacturing surveys that pointed to ongoing difficulties as a result of the high U.S. dollar and weak global demand.

Globally, growth remained disappointing. In Europe, weak growth prompted speculation that in early December the European Central Bank would increase its monetary stimulus by cutting its deposit rates and increasing its quantitative easing programme. [As this is being written, the ECB has announced relatively minor increases to its monetary stimulus, which has disappointed bond markets.] Chinese data also was below forecasts leading to further declines in commodity prices and reducing expectations for commodity dependent economies.

The U.S. bond market, which often provides direction to the Canadian market, experienced flattening of its yield curve in November. Yields of 2-year U.S. Treasury Bonds rose 25 basis points, as investors anticipated the Fed would begin raising short term interest rates in December. Yields of 30-year U.S. Treasuries, however, increased only 6 basis points. In Canada, the yield curve also flattened, but the changes were more modest, with 2-year Canada Bond yields rising only 6 basis points. Yields of 30-year Canada’s actually declined 2 basis points in the period, as investors anticipated that early-December index rebalancing would increase demand for long term bonds.

The federal sector earned 0.00% in the month as slightly higher yields resulted in small declines in prices that exactly offset interest income. The provincial sector returned -0.07%, with provincial yield spreads widening an average of 3 basis points. In contrast, corporate yield spreads narrowed 2 basis points on average, resulting in the sector gaining +0.45%. New corporate issuance in November was quite light at $3.3 billion, so ongoing investor purchases caused spreads to tighten modestly. High yield corporates fared less well, returning -0.43%, with energy related issues particularly weak. Real Return Bonds gained 1.02%, as the core rate of inflation remained above 2.0% for the 15th consecutive month. Preferred shares declined 1.24%, with tax-loss selling pushing down the values of rate reset issues.

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