The main event within the second quarter was the surprise vote from the UK to “Leave” the EU. Days prior to the June 23rd referendum, equity markets rallied in anticipation of a “Remain” outcome. Instead, the UK’s vote to leave the EU triggered increased economic and market uncertainty and was felt within all facets of capital markets; stock markets dropped, the US dollar advanced, bond yields flirted with record lows to name a few. Table 1 reflects the impact of Brexit within days of the vote.
Looking at both the UK and EU, economic implications are still largely uncertain however, it is clear that business confidence globally has been negatively impacted affecting both investment appetite and economic growth momentum. The Bank of England is expected to implement rate cuts (current level 0.50%) and expand their quantitative easing program. The European Central Bank will continue with their quantitative easing program and may in fact extend it beyond next March if market volatility threatens the EU’s fragile recovery.
The US economy started off the year slower than predicted; however, it wasn’t nearly as disappointing as the initial data suggested. During Q2, the US Q1/2016 GDP was revised upward to 1%; very close to market expectations. Although recent payroll figures have raised questions about the durability of consumer spending, there has been solid job gains and wage growth supporting the US consumer. With an upward revision and evidence of stronger consumer spending, US growth is on pace for a 2% annualized rate in the first half of 2016. Regarding the Federal Reserve Board, prior to Brexit, they maintained a cautious wait-and-see attitude. Since Brexit, global risks have come to the forefront and will likely lead the Fed to postpone any rate hike until the first quarter of 2017 even if labour market conditions continue to improve as expected. Going forward we see 10 year Treasuries trading in a range of 1.2% - 2% for the next 12 months.
In Canada, there was one notable event that occurred in Q2; Fort McMurray wildfires. As a result, the Canadian economy is expected to contract by approximately 1.0% in Q2 due to shutdowns in the oil sector. However, growth is projected to rebound in Q3 because of related cleanup and rebuilding work in the region as well as production returning to normal levels. Brexit will have a minimal direct impact on the Canadian economy. Instead, the impact will be seen indirectly through business investment and consumer confidence. Finally, the Bank of Canada is now expected to hold the overnight rate steady at its current level of 0.50% well into the second quarter of 2017. Going forward, we see 10-year Government of Canada’s trading in a range of 0.9-1.3% for the next 12 months.
Following a strong first quarter in both corporate and provincial bonds, we continued to see investor sentiment improve and spreads narrow. Year to date, mid-corporates (5-10 years) have returned 4.71%, mid-provincials 3.92% and mid-Canada’s 3.43%. Furthermore, it is important to note the strong performance in both telecommunications 5.34% (Telus and Bell) and energy 4.84% (Enbridge and TransCanada). Finally, corporate and provincial bonds in both the short and long indices outperformed Canadas. Going forward, we will continue to overweight corporate and provincial bonds relative to Canada’s and extend the duration of the bond portfolio as inflation and economic growth is projected to remain low.