Looking ahead, we anticipate that Canadian economic growth will be shown to have grown at a pace faster than 3% in the third quarter. That should reduce speculation about the Bank of Canada possibly reducing interest rates for the next few months. However, the pace of Canadian growth will likely return to more anemic levels in subsequent quarters. Unless the oil production agreement recently announced between OPEC and Russia results in a sharp spike higher in oil prices, we do not expect a sharp rebound in Canada’s energy sector. A slow, grinding recovery seems more likely. As this is being written, the federal government has announced changes to mortgage eligibility rules and capital gains tax exemptions for foreign buyers of Canadian housing. These changes are likely to slow the housing sector, but scale of the impact is difficult to forecast at this time. At this time, we believe that Canada is not likely to fall into a recession and, with historically attractive yield spreads, we are maintaining the over-weight allocation to the corporate sector.

In the United States, we expect the Fed will raise rates at its December meeting. Before then, the bond market will likely start anticipating the Fed’s move and U.S. bond yields will move higher. Given the high correlation between the Canadian and American bond markets, higher U.S. bond yields should put upward pressure on Canadian yields. While the Bank of Canada is not expected to follow the Fed if it raises rates, shorter term Canadian bond yields are vulnerable to a U.S. shock. Currently, 5-year Canada Bonds yield 0.62%, or only 10 basis points more than 2-year Canada’s, and they offer little protection if investor sentiment begins to anticipate any Bank of Canada tightening in the distant future. Accordingly, we are minimizing holdings of shorter term bonds in favour of a combination of longer term issues and cash equivalents.

Three months ago, the Brexit vote shocked the markets and caused some temporary volatility. The markets settled down subsequently because it was not clear when Britain would actually choose to start the process to leave the European Union. However, as this is being written, UK Prime Minister Theresa May has stated that her government will trigger the formal notice of departure by March 2017. While most of the negative economic impact of Britain leaving will be confined to Britain, the lead up to the notice is likely cause some market volatility. Canada’s bond market may benefit, given its safe haven status. Given the potential for increased volatility and the ongoing quantitative easing by the European Central Bank and the Bank of Japan, we are keeping portfolio durations close to benchmarks at this time.

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