Canadian bond yields fluctuated in a narrow band in November. The yields initially drifted higher as investors reflected on the Bank of Canada’s October 30th announcement that it did not anticipate further rate reductions. Later in the month, though, some weaker than expected economic data in the United States caused a rally in Treasuries that prompted Canadian yields to fall back toward their opening levels. On November 4th, the Government of Canada released its first budget in a year and a half, but it did not have much impact on the bond market. Also in the month, the U.S. government shutdown ended, which will allow more economic data to resume publication. The FTSE Canada Universe Bond index returned 0.27% in November.

Canadian economic data was generally positive in November. The unemployment rate unexpectedly declined to 6.9% from 7.1%, as a second consecutive month of robust job creation more than offset a rise in the participation rate. Canadian GDP was estimated to have grown at an annual rate of 2.6%, well above consensus expectation of 0.5% growth. In addition, estimates of GDP growth in the last three years were revised higher, suggesting there was less slack currently than had been thought. Inflation declined to 2.2% from 2.4%, and the core measures of inflation declined to 2.95% from 3.10% the previous month.

The federal budget forecast a deficit of $78 billion, much higher than its previous estimate of $42 billion, but well below some predictions that were as high as $100 billion. The government had anticipated the deficit to be sharply higher and it had increased the pace of bond issuance last spring to help fund the increase. Going forward, the amount of gross issuance is expected to slow modestly, but with fewer maturities scheduled for next year net issuance will be much higher. Despite the large jump in the size of the deficit, the bond market reaction was muted because the deficit was not as bad as some had feared.

As noted above, the U.S. government shutdown ended in November, which permitted the release of some stale data collected prior to the shutdown. Of particular note, the unemployment rate rose to 4.4% in September, up from 4.3% the previous month. Outside of the pandemic, it was the highest unemployment rate in eight years, and it spurred buying of U.S. Treasury bonds as investors believed it made a December rate cut by the Federal Reserve more likely. That the rise in the rate was caused by a higher participation rate (more Americans joining the labour force) was ignored by the bond market, as was the much better than expected job creation in the month. A more current reading on the labour market will not come until December 16th, after the Fed makes its next interest rate decision.

The Canadian yield curve moved marginally higher in November as the yields of all benchmark Canada bonds rose 1 to 2 basis points. With the Bank of Canada indicating that it was likely to leave rates unchanged, bond investors had little reason to bid up bond prices. In contrast, speculation that the Fed might reduce rates in December caused the U.S. yield curve to steepen. The yield of 2-year Treasuries declined 11 basis points, while the 30-year Treasury yield was unchanged in the month.

The federal sector returned 0.15% in November as small price declines partially offset the interest earned on bonds. The provincial sector gained 0.47%, benefitting from a 2 basis point narrowing of yield spreads versus Canada bonds. The corporate sector earned only 0.23% in the period as the yield spreads on short and mid term corporate bonds widened 2 basis points. Non-investment grade corporate bonds returned 0.47%, reflecting stable prices and their higher yields. Real Return Bonds earned 0.28%, which was slightly better than nominal bonds. The higher than expected inflation data was likely the reason for the positive RRB result. Preferred shares paused their strong 2025 performance, edging down 0.08% in the month, but are still up more than 14% this year.

We believe the Bank of Canada will leave interest rates unchanged at its December 10th announcement. Without further encouragement from the Bank of Canada, we believe bonds are likely to remain in a trading range. We also believe the current “normal” shape of the yield curve is appropriate and additional steepening is unlikely. We remain cautious about the corporate sector as the current yield spreads are not properly pricing the level of economic and financial risk.

Anticipating what the Fed will do at its December 10th meeting has become more challenging than in recent years, not least because the Federal Open Market Committee appears quite divided in its views. Since Trump appointed Stephen Miran as a Fed governor in September, Miran has frequently tried to explain why he has been advocating more aggressive rate cuts than the rest of the committee. Whereas in the past, committee members did not very often disclose their opinions regarding future rate moves, Miran’s frequent comments seem to have encouraged other committee members to publicly discuss their opinions. And those comments have disclosed substantial disagreements on both inflationary pressures and the pace of economic activity in the United States. We still believe the Fed will leave rates unchanged on  December 10th, but we recognize that a rate cut is quite possible.

Going forward, we see several potential sources of volatility in the next few months. Clearly trade negotiations remain a source of risk, with Trump potentially using a threat of cancelling the USMCA as a negotiating tactic. Elevated equity valuations are another risk, as price/earnings ratios are at historically high levels. Should stock markets correct, we would expect a flight-to-safety bid to occur for government bonds, but underperformance of corporate issues as yield spreads widen from very narrow levels. We are also concerned that all of Trump’s threatened tariffs have not been fully implemented, so their negative economic impact has not yet occurred. And a final concern is the selection of the next Chair of the Fed. Should Trump choose a candidate that is perceived as wanting excessive easing with insufficient concern regarding inflation, bond investors may vote with their feet.