Investors in various markets became more optimistic about economic growth in October. As a result, riskier assets, including U.S. equities, enjoyed good gains. Canadian equities initially followed suit, but then struggled as oil prices moved lower. The risk-on sentiment reduced demand for bonds, but the key focus for fixed income investors was when the U.S. central bank would begin tightening monetary policy. For most of October, bonds fluctuated between small gains and small losses. A surprise statement from the Fed close to the end of the month resulted in bond prices finishing slightly lower than month earlier levels. The FTSE TMX Canada Universe Bond index returned -0.26% in the month.

Canadian economic data received in October pointed toward disappointingly slow growth. Growth in GDP in the most recent month (August) was only +0.1%, and the increase in the last year was an anemic +0.9%. Unemployment ticked up to 7.1% from 7.0%, but the details of the labour data were suspiciously volatile. In particular, there was a substantial shift from full time positions to part time jobs (-61,900 versus +74,000) and more than 51,000 jobs in education were supposedly lost in September. The size of these shifts seemed less than credible and warranted some caution. In other news, retail sales and housing starts were stronger than expected, but the trade deficit widened as exports fell and imports increased. The Bank of Canada left interest rates unchanged, but sounded slightly dovish in its statement. With regard to the change in government as a result of the federal election, the Bank made no changes to its forecasts as it awaited the actual policies of the new government. With the Liberal Party having campaigned on fiscal stimulus through increased spending on infrastructure, the Bank will likely be patient before implementing additional monetary stimulus.

U.S. economic data was mixed in the month, frustrating investors trying to anticipate when the Federal Reserve might start raising rates in that country. The initial estimate of GDP growth in the third quarter was +1.5%, significantly slower than the second quarter pace of +3.9%. The reduction in economic growth was primarily due to a sharp drop in inventories, though, as final domestic demand increased by a more robust 3.0%. Unemployment held steady at 5.1%, but job creation was weaker than expected and the participation rate fell to 62.4% from 62.6%. Retail sales were disappointing and industrial production shrank again on manufacturing weakness. The trade balance deteriorated, with exports declining and imports rising. On the positive side, housing starts were stronger than forecasts and initial claims for state unemployment benefits fell to the lowest level since 1973.

Late in the month, the Fed left interest rates unchanged as expected, but its accompanying statement contained a few surprises. In its previous statement, the Fed had raised concerns about global economic growth, but in the October version there was little mention about global growth, even though the global situation had not meaningfully changed. The second surprise was a comment that the Fed would be considering a rate increase at its December get-together. The statement made it clear that a December rate increase had not yet been decided, but the comment did cause many observers to re-evaluate the likelihood of an increase. A number of Fed speakers since the September meeting had made dovish remarks implying the first increase would wait until next year, so the October emphasis on a possible December move surprised investors and caused U.S. bond yields to move higher and prices lower. Canadian bonds followed the lead of the U.S. bonds.

The Canadian yield curve shifted slightly higher in October as yields on benchmark Canada Bonds of all maturities increased between 5 and 10 basis points. The small change in yields meant that short term bonds were unchanged in the month as price declines exactly offset interest earned. Long term bonds, however, declined 0.71% as the yield changes resulted in larger price moves.

The small increases in yields caused federal bonds to return -0.38% on average. Provincial bonds fared better, notwithstanding their longer average durations, returning +0.02%. Provincial yield spreads narrowed 7 basis points following the election as investors anticipated the change in the federal government would benefit provincial coffers. In contrast, investment grade corporate bond yield spreads widened 2 basis points on average, resulting in that sector earning -0.42% in the period. Corporate yield spreads had initially widened sharply in the early October, but reversed course as new issue supply remained low and investor sentiment improved. Non-investment grade issues earned +0.23% buoyed by limited new supply and the risk-on sentiment that prevailed during the month. Real Return Bonds returned -1.55%, as their yields moved in sync with nominal Canada Bond yields, but the longer duration of RRB’s resulted in larger price moves.

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