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For most of July, politics rather than economics dominated the bond markets’ attention. Dithering by European leaders over another aid package for Greece and other bailed-out countries prompted concerns that it was insufficient to stop the sovereign debt crisis from spreading. In particular, the prices of bonds issued by Spain and Italy fell sharply and their yields moved higher. A second major political debate affecting the market was the U.S. debt ceiling negotiations that dragged on to the 11th hour. The poisonous, polarized political atmosphere in Washington threatened the United States’ AAA rating and raised the spectre of a default on its debt. International investors, seeking to protect their capital in light of both of these crises, were attracted to Canada’s better fiscal and economic situation. Robust foreign demand for Canadian bonds, especially those issued by federal and provincial governments, pushed bond prices higher and yields lower. The Canadian bond market also received support from faltering economic data, weak equity markets and a surprisingly strong U.S. Treasury market. The DEX Universe Bond index returned 2.04% in July, the strongest monthly gain since December 2008.
Canadian economic data was mixed. On the positive side, housing starts and retail sales were somewhat stronger than expected. International securities transactions for May confirmed that net foreign buying of Canadian bonds was robust at $11.1 billion. Unemployment held steady at 7.4%, with 28,400 new jobs created. Inflation unexpectedly fell to 3.1% from 3.7% the month before, as the prices of new cars and gasoline each fell sharply. On the negative side, Canadian GDP declined 0.3% in May. While the mining and oil and gas extraction sectors were particularly weak due to wildfires in Northern Alberta as well as routine maintenance shutdowns, other parts of the economy also experienced slower than expected growth. The manufacturing sector was impacted by the strong Canadian dollar, weak U.S. demand, and supply problems caused by the Japanese earthquake and tsunami.
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