Bond yields moved sharply higher in the first week of October with the news of the successful renegotiation of NAFTA and the prospect of a Bank of Canada interest rate increase later in the month that was reinforced by strong labour market data. However, yields moved lower over the next three weeks as precipitous drops in global equity markets resulted in a mild flight-to-safety bid developing for bonds. Examples of the equity moves included the S&P 500 correcting by over 11% from its all-time high reached in late September and the S&P/TSX index dropping almost 9% from its level at the start of the month. With economic data remaining favourable and most corporations reporting strong earnings, the flight-to-safety bid for bonds was tempered by the likelihood that the equity selloff was simply a mid-cycle correction rather than a harbinger of an impending recession. By October 29th, though, most bond yields had fallen back to their levels from the start of the month. Only when equities rallied robustly in the final two days of the month did bond yields resume rising and prices declined. The FTSE Canada Universe Bond index returned -0.61% in October.

Canadian economic data received in October was generally positive but showed some signs of slowing. Unemployment fell to 5.9% from 6.0% a month earlier and Canadian GDP growth in the last 12 months accelerated to 2.5%. However, retail sales were weaker than expected and average hourly earnings growth slowed to 2.2% from 2.6%. Inflation was well below forecasts; the annual rate dropped to 2.2% from 2.8%.

As expected, the Bank of Canada raised its interest rates by 25 basis points on October 24th. In its accompanying statement, the Bank indicated that additional future increases in interest rates were likely, but it no longer said such increases would be “gradual”. This relatively minor change was interpreted by some observers to mean the Bank was likely to be more aggressive in raising rates, but the Bank was simply trying to distance itself from the consensus interpretation that “gradual” meant “quarterly”. The Bank’s rate increase had been largely anticipated, but the hawkish interpretation of its statement caused short term yields to briefly move higher.

In the United States, the economic news remained favourable. Unemployment fell from 3.9% to 3.7%, the lowest level since December 1969. In addition, growth in U.S. GDP during the third quarter was stronger than forecasts at a 3.5% annual pace. Not unexpectedly, consumer confidence was buoyed by the excellent labour market conditions and rose to an 18-year high. Interestingly, inflationary pressures have not built up in the robust economic environment as the inflation rate declined to 2.3% from 2.7% the previous month. However, we don’t believe the drop in the inflation rate, if it lasts, will deter the Fed from raising interest rates again in December.

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