The Canadian yield curve moved higher in a near parallel fashion, with 2-year and 30-year Canada yields rising 10 and 11 basis points, respectively. Mid term bond yields rose slightly less, and the slight inversion of 10 and 30-year yields reverted to a positive slope. In the U.S. bond market, the yield curve steepened as 2-year Treasury yields rose only 2 basis points while 30-year yields jumped 19 basis points. A reduction in demand for long duration bonds by pension funds combined with growing federal issuance to fund a burgeoning fiscal deficit to push long term bond yields higher.

The Canadian federal sector returned -0.33% in October, as higher yields resulted in lower bond prices. Provincial bonds returned -0.90%, on average, with their longer durations resulting in larger price declines. As well, provincial yield spreads edged wider by a basis point. The corporate sector earned -0.62% in the month. The risk-off sentiment caused by the equity volatility led to a widening of corporate yield spreads by an average of 6 basis points. The turbulence in equities also led to reduced new issue supply which, at $4.4 billion, was roughly half the pace of the same month a year ago. The average yield of non-investment grade corporate bonds jumped 22 basis points in the month, but their shorter average duration limited the price impact and junk bonds returned -0.53% in the period. The surprising decline in the inflation rate negatively impacted Real Return Bonds, as they returned -2.03%. The risk-off sentiment caused preferred shares to fall out of their 16-month long trading range in October. A lack of liquidity resulted in considerable volatility, particularly in the second half of the month. For the month as a whole, preferred shares returned -2.74%.

Having been defensive for months, we increased the portfolio duration closer to that of the benchmark in October in reaction to rising equity volatility (investment-speak for sharply lower prices). However, we believe the equity market selloff is most likely a mid-cycle correction, rather than a harbinger of the growth cycle ending and a recession beginning. As a result, we are monitoring the equity market for indications that it is stabilizing and potentially resuming its upward trajectory. Assuming that occurs, we will look to reduce the portfolio duration again.

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