The Canadian bond market during September gave up almost all of its gains from August. Rising yields in the U.S. bond market led to higher yields and lower bond prices in this country. The sell-off in Canada was exacerbated, however, by a slightly surprising rate increase by the Bank of Canada. As a result, the increases in Canadian yields were larger than the moves in the U.S. market. The FTSE TMX Canada Universe Bond index returned -1.32% in September.

On September 6th, the Bank of Canada surprised many market participants by making a second consecutive 25 basis point increase in its overnight target interest rate. In doing so, the Bank completed the reversal of its rate cuts of 2015. The market consensus had expected the increase to occur at the Bank’s October 25th announcement date, and the earlier move led to a sharp drop in bond prices and increases in bond yields. Some investors assessed the Bank’s move as quite aggressive and they anticipated an additional rate increase would occur at the October meeting. However, over the balance of September, those expectations receded and short term bond yields declined modestly from their highs of earlier in the period.

Canadian economic data received during September was generally supportive of the Bank of Canada’s decision to remove some monetary stimulus. The unemployment rate declined from 6.3% to 6.2%, the lowest level in nine years. Housing starts remained robust, likely boosted by demand created by Canada’s non- refugee immigration policy. In addition, inflation edged higher to 1.4% from 1.2%, and retail sales were stronger than expected. Monthly growth in GDP was a little disappointing, but the year-over-year growth of 3.8% remained quite strong.

The Canadian dollar initially strengthened following the Bank of Canada’s move, rising to its highest level in over two years. However, subsequent comments from Bank Governor Stephen Poloz that suggested additional rate increases would be gradual and data dependent led to a rally in short term bonds and weakness in the exchange rate. The Loonie finished the month little changed.

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