Despite higher Canada bond yields and ongoing geopolitical risk in August, the preferred share market followed up a very strong July with another positive month. Investor concerns about persistent inflation, large AI related corporate bond issuance, and high levels of government debt, particularly the U.S., combined to push bond yields higher in several global bond markets. The month also featured a noisy breakdown in trade negotiations between Canada and the United States, with the imposition of more punitive U.S. tariffs and the threat of Canadian retaliatory tariffs.

During the month, there were two redemptions announced and one new issue. The trend to higher bond yields created divergent performance among the preferred share types, with perpetual issues having a negative return of 0.4% and rate reset issues having a positive return of 0.9%. The S&P/TSX Preferred Share Index ended the month with a return of 0.27%.

Canadian economic data received during August showed a growing resilience to the trade war, albeit prior to the increased threats from the U.S. On balance, the data provided no impetus for the Bank of Canada to adjust monetary policy. Canadian GDP rebounded in the second quarter, growing at a 3.3% annual pace and the first quarter growth estimate was revised to +0.3% from -0.1%, thereby eliminating concerns of a technical recession. The unemployment rate edged down to 6.4% from 6.5%, as robust job creation more than offset higher worker participation. Canada recorded its fourth consecutive monthly trade surplus, and retail sales grew faster than forecasts. Inflation accelerated to 3.0% from 2.8% on higher energy prices, but each of the Bank of Canada’s measures of core inflation remained subdued at or below 2.0%.

Early in the month, Intact Financial issued a $250 million Limited Recourse Capital Note with a 6.133% coupon and a reset spread of 275 basis points and announced the redemption of the $250 million IFC.PR.C series, with a reset spread of 266 basis points, on September 30th. The series had been trading above par for several months and there was not a significant move in its price on the news. In contrast, Canaccord Genuity announced the redemption of the $114 million CF.PR.A series, with a reset spread of 321 basis points, on October 1st, which did surprise the market. The lightly traded series moved up almost a dollar on the announcement.

In August, there was one new preferred issue, which had solid demand from institutional and retail investors. Brookfield Infrastructure LP issued $150 million BILP.PR.A rate reset units with a floor distribution rate of 5.75% and a reset spread of 235 basis points. Distributions will be a fluctuating combination of dividends, return of capital, and interest. The issue finished the month trading above par. Also, Brookfield Corp announced it received approval from the TSX for the renewal of its Normal Course Issuer Bid to purchase up to 10% of the public float of each of its preferred share series.

During the month, one preferred share series reset its dividends. The dividend rate reset significantly higher because the 5-year Canada bond yield is substantially higher than five years ago. Details of the resetting issue were as follows:

IssueExisting Fixed Dividend Pricing DateExisting Dividend RateNew Fixed Dividend RateNew Floating Dividend Rate
SLF.PR.HAugust 20212.967%5.519%4.459%

Investors in SLF.PR.H and the outstanding connected SLF.PR.K floating rate series will have until September 16th to make their decision to remain in their series or switch to the other series. Also, as this is being written, Brookfield Office Properties announced that they will not be redeeming the BPO.PR.R series. The new fixed dividend rate and initial floating dividend rate will be 6.829% and 5.770%, respectively. Investors will have until September 15th to make their decision to remain in the series or switch to the related floating rate series.

During the month, the seven largest preferred share ETFs had an aggregate inflow totaling $62 million. Only the actively managed NPRF had an outflow, which was less than $1 million.

J. Zechner Associates Preferred Share Pooled Fund

In August, the fund had a return of 0.08%, which was slightly lower than the S&P/TSX Preferred Share Index. The shortfall was largely a function of a few positions trading down disproportionally on low trading volumes in August.

Portfolio activity during the month included selling the remaining MFC.PR.K position at a yield to call below 4.00%. These proceeds were used to add to MIC.PR.A at a yield of approximately 5.75% and PPL.PR.A at a yield to call of approximately 5.80%. In addition, we purchased some ZPR, the passive rate reset index ETF, as a placeholder until additional attractive purchases can be made.

Outlook and Strategy

As this is being written, the Bank of Canada has left its overnight target interest rate at 2.25%, as was widely expected. The Bank said it was concerned that the lack of progress in reopening the Strait of Hormuz meant the risk of inflation broadening beyond gasoline prices was increasing. At the same time, the Bank noted the economy was not operating at full capacity plus “uncertainty is high and new US tariffs and threats of further action pose risks to the sustainability of the recovery.” The market’s initial reaction to the Bank’s announcement was that the reference to increased inflation risks was hawkish, but we believe the offsetting risks of rising inflation and weaker growth will keep the Bank on the sidelines for the balance of the year.

As we noted last month, the war between the United States and Iran remains a wildcard for financial markets. The complete lack of trust between the two countries and the absence of any common interests suggest it may drag on for several more months. The upcoming mid-term elections in the United States in early November combined with the unpopularity of the war in the U.S. means Iran has little reason to negotiate a settlement in the next couple of months.

The upcoming mid-term elections may also have an impact on the trade war between Canada and the U.S. Political polls currently suggest the Republican party may lose control of both the House and the Senate, and if the polls do not improve the Trump Administration may become more accommodating in negotiating a trade agreement so as to achieve some positive news. In other words, Canada’s negotiating leverage should improve until the elections, but will fall after then.

We are increasingly concerned about weakness in global bonds posing a risk to Canada bond yields. One worry is the Yen carry trade, a decades-old financial structure that took advantage of very low interest rates prevailing in Japan and higher yields available elsewhere in the world. Investors, including large Japanese institutions, borrowed in Yen and reinvested in higher yielding assets in other currencies including the U.S. dollar. The recent rise in Japanese yields, though, is reducing the attractiveness of the Yen carry trade, which may lead to selling of foreign currency assets and repatriation of Japanese investments to Japan. The Bank of Japan is under substantial pressure to stabilize the value of the Yen, because its depreciation is leading to higher Japanese inflation as import costs rise. Interventions by the BoJ are providing only temporary relief for the Yen, and it needs to raise interest rates to provide a longer lasting solution. Higher interest rates, however, will likely lead to rising Japanese bond yields that, in turn, will lead to more unwinding of the Yen carry trade. Foreign asset sales, or even anticipation of selling, could lead to significant upward pressure on global bond yields.

In August, the 5-year bond yield remained well above the extremely low level of five years ago resulting in the resetting issue increasing its dividend rate more than 250 basis points. We expect the 5-year Canada bond yield to remain in a trading range near current levels. Therefore, we continue to anticipate large increases in resetting dividend rates in the coming months. However, absent a significant rise in the 5-year Canada bond yield these increases are likely to decline over the coming months, given that starting in September 2021 the 5-year Canada bond yield increased approximately 200 basis points over the next nine months.

As demonstrated this month, we continue to believe corporations will look for opportunities to issue LRCNs and hybrid bonds at attractive coupons and reset spreads that will enable them to reduce their after-tax cost of capital by redeeming high reset spread series. However, with only one issue, which is unlikely to be redeemed, resetting over the remainder of 2026, the redemption trend that has supported the market will likely be limited in the near term. Notwithstanding, we remain optimistic about preferred share returns because they offer attractive tax-advantaged dividend income that investors continue to seek.