The overly pessimistic economic outlook of late 2018 was alleviated in January as various financial markets switched from anticipating an imminent recession to expecting that the pace of growth would slow but remain positive. Equity markets were particular beneficiaries of the improved outlook, with the S&P/TSX Composite jumping 8.5% in the month, and the S&P 500 index gaining 7.9% (in U.S. dollar terms). In part the equity rally also reflected expectations that central banks would raise interest rates more slowly than previously thought. The lower anticipated trajectory for interest rates led to a modest rally in bonds and slightly lower yields. The more positive economic outlook had an even greater impact on provincial and corporate bonds which benefitted from narrowing yield spreads in the month. The FTSE Canada Universe Bond index returned 1.34% in January.

Canadian economic data received in January was mixed. Unemployment remained at 5.6%, the lowest rate in over 40 years. Inflation was not as weak as anticipated, and the year-over-year pace accelerated to 2.0% from 1.7%. The price of oil surged almost 19% in the month, which led to a 3.6% rally in the Canadian exchange rate. Less positively, sales of existing homes finished on a weak note as tougher borrowing requirements and higher mortgage rates caused demand to fall. In addition, wholesale trade, manufacturing sales, and retail sales all shrank in November, suggesting the Canadian economy experienced negative growth that month. Indeed, on the final day of the month we learned that the Canadian economy shrank -0.1%, the second decline in the last three months. The Bank of Canada left interest rates unchanged, but it indicated that it thought the slowing of growth was temporary and the economy would resume faster growth in the second quarter of this year.

The U.S. government shutdown meant that many economic statistics were delayed and investors had to make do with a less complete picture of the country’s economic health. The unemployment rate rose to 3.9% from 3.7%, as an increase in the participation rate more than offset robust job creation. Industrial production was better than expected, but consumer and business sentiment surveys were weaker than anticipated due to ongoing trade tensions and the prolonged shutdown. U.S. CPI fell to 1.9% from 2.2% the previous month, and the lack of inflationary pressures meant the U.S. Federal Reserve could be more patient in raising its interest rates in 2019. Some observers also began speculating that the Fed might slow the runoff of its bond holdings in reaction to decelerating growth and the rising U.S. fiscal deficits. The potential for less monetary policy tightening helped push up bond prices.

On January 30th, the Fed left its interest rates unchanged, as expected. However, the accompanying statement was more dovish than anticipated in that it removed previous references to the need for future gradual rate increases. Instead, the Fed said it will be patient in assessing the need for rate changes, either up or down in direction. As a result, the consensus view changed from anticipating Fed Rate increases in June and December to possibly only one this year in September. In addition, the Fed confirmed that it was prepared to adjust the pace of reducing its holdings of bonds and that it might not reduce the size of its balance sheet to pre-crisis levels.