In the United States, the economy appeared to be operating at full capacity, although some of the data was distorted by hurricanes Harvey and Irma, which caused some temporary business closures, as well as a spike in gasoline prices. The debt ceiling crisis, which risked a government shutdown, was averted by a short term deal between President Trump and the Democrats in Congress.

As expected, the Federal Reserve left its overnight interest rate unchanged and announced that it would start allowing its holdings of government bonds and mortgage backed securities to gradually unwind. Starting in October, the Fed will no longer fully reinvest the interest payments and maturities of its bond holdings. Each month of the fourth quarter, the Fed’s holdings will shrink by a total of $10 billion, with Treasury holdings declining $6 billion and MBS holdings declining $4 billion. Every quarter next year, the monthly run-off will increase by $10 billion, leveling off at $50 billion in the fourth quarter of 2018. The Fed’s announcement was widely anticipated and had little impact on the market. Subsequent remarks by Fed Chair Janet Yellen, however, reminded investors that another rate increase was possible at the Fed’s December meeting, and that contributed to the weakness in bond prices over the balance of the month.

Benchmark Canadian bond yields rose 21 to 27 basis points across all maturities in September. The moves paralleled higher U.S. yields, but were 4 to 8 basis points larger than the shift in Treasury yields because of the Bank of Canada’s rate increase. The jump in yields caused bond prices to decline, leading the federal bond sector to return -1.18%. The provincial sector, which has higher average durations and is therefore more susceptible to yield increases, returned -1.66% in the month. Provincial yield spreads narrowed 2 basis points in the month, which mitigated the impact of higher benchmark yields. The investment grade corporate sector outperformed government bonds in the month, returning -1.09%. Demand for corporate bonds remained strong; yield spreads narrowed by a basis point in spite of a record $14.3 billion of new fixed rate issues in the month. Among the new issues were $1.6 billion of Maple bonds and a $1 billion hybrid from Enbridge Inc. The hybrid is a junior, subordinated debenture that permits the company to halt interest payments for up to 5 years. If interest payments are halted, the company is not allowed to pay dividends on either its common or preferred shares. Non-investment grade corporate bonds earned +0.61%. Real Return Bonds suffered because of their long average durations, returning -1.99% in September. RRB’s outperformed the -2.59% return of nominal long term bonds, which have a similar average duration, as inflation accelerated modestly. Preferred shares continued to demonstrate their lack of correlation with bonds, earning +1.36% in the month.

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