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Jeff Herold
November 7, 2018
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.
Our investment management team is made up of engaged thought leaders. Get their latest commentary and stay informed of their frequent media interviews, all delivered to your inbox.