Bonds once again proved their value as a safe haven in December, as other financial markets suffered sharp losses. Concerns that global growth was slowing as a result of the U.S. trade war with China, tariffs, higher borrowing costs, and diminishing effects from the December 2017 U.S. tax cuts made investors nervous and led to sharp declines in equities and some commodities. In Canada, the S&P/TSX equity index fell 5.4% in December, while in the United States the S&P 500 and Nasdaq indices plunged 9.0% and 9.4%, respectively. Adding to the gloom, the cumulative losses since it hit its late-August high left the Nasdaq index down more than 20%, the technical definition of a bear market. The price of oil dropped 10.8% in December, leading the Canadian dollar to weaken 2.5% versus the U.S. dollar. The equity volatility produced a flight-to-safety bid for government bonds that was strengthened by expectations that the U.S. Federal Reserve and the Bank of Canada would slow the pace of their interest rate increases in the coming year. Yields of benchmark Canada bonds fell sharply as a result and their prices rose. Corporate bonds also enjoyed gains but those were pared because their risk premiums versus government bonds increased. Having produced little net returns through the first eleven months of the year, the good December result meant bonds finished the year with a small positive return. The FTSE Canada Universe Bond index returned 1.36% in December, bringing the return for all of 2018 up to a very similar 1.41%.

Canadian economic data received in December was generally strong. Unemployment fell to 5.6%, the lowest level on record, as robust job creation more than offset a jump in the participation rate. Housing starts were stronger than expected, led by higher starts of single-detached homes. In addition, the growth in Canadian GDP during October was slightly better than expected and the year-over-year pace accelerated to 2.2% from 2.0% the previous month. Less positively, retail sales were below estimates and the trade deficit widened because of a 15% decline in oil export prices. Inflation declined to 1.7% from 2.4%, slightly weaker than forecasts due to weaker gasoline prices. Early in the month, the Bank of Canada left its interest rates unchanged, as expected. In its announcement, the Bank acknowledged recent downside risks (viz. lower oil prices and the trade war), but it anticipated that interest rates would need to rise further to reach a neutral level for the economy.