Market Commentary
At its July 28-29, 2026 meeting, the Federal Open Market Committee (FOMC) maintained the federal funds target range at 3.50% to 3.75%. Three members dissented in favour of a rate increase amid elevated energy and inflation pressures. A higher incidence of dissent may become more common under Chair Kevin Warsh. With forward guidance no longer a central feature of the Fed’s communication framework, there is less need to build consensus around a pre-communicated policy path, although the Chair continues to exert significant influence over Committee deliberations.
The decision was subsequently supported by softer-than-expected July inflation data. The headline Consumer Price Index (CPI) data eased to 3.4% year-over-year from 3.5% in June, while monthly CPI rose just 0.1% following a 0.4% decline. Producer prices also moderated: July Producer Price Index (PPI) slowed to 4.7% year-over-year from 5.5%, while the monthly reading was unchanged after a 0.1% decline in June. To date, inflationary pressure associated with higher energy prices does not appear to have broadened persistently across the U.S. economy.
At its July 15 meeting, the Bank of Canada also held its policy rate at 2.25%, citing signs of economic stabilization while continuing to monitor energy-related inflation risks.
Renewed tensions in the Middle East temporarily pushed crude oil prices higher. Against this backdrop, the yield on the Government of Canada long bond rose from 3.78% to 4.05% during July, while the 2-year yield increased from 2.75% to 2.91%.
The Canadian yield curve steepened modestly in July, with the 2s30s spread (the financial difference between the yield on the 30-year Treasury bond and the yield on the 2-year Treasury note) widening to 1.13% from 1.03% at the end of June. In our view, this leaves further scope for curve flattening as economic conditions weaken. The Canadian long bond outperformed its U.S. counterpart by 0.05%, while the yield spread widened from 1.17% to 1.22%. The Fund continues to favour the Canadian long bond, both on a relative-value basis within Canada and versus the U.S. long bond.
During July, the U.S. dollar weakened from approximately 1.42 to 1.40 versus the Canadian dollar. Given previously severe overbought conditions in USD/CAD, the Fund remained on the sidelines and avoided the downside associated with the currency reversal. USD/CAD was last near 1.3940.
Fund Performance and Positioning
The Fund remains positioned for a weaker Canadian economy through exposure to 30-year Government of Canada bonds. During July, it increased long-bond exposure at lower prices, extending duration from 4.3 years to 7.4 years.
USD/CAD declined from 1.42 to 1.40 in July as severely overbought conditions corrected. The Fund will seek opportunities to re-establish a long USD/CAD position when valuation and technical conditions are more favourable. Performance for the month of July fell 1.4%. The S&P Canada Sovereign Bond TR Index dropped 1.23%. Year-to-date, the Fund has outperformed its benchmark by 70 basis points.
Outlook
Inflation measures in the U.S. and Canada are moderating, suggesting the impact of higher energy prices has likely crested. However, soft nominal wage growth, declining savings rates, weak business investment and a soft housing market continue to pressure the Canadian economy. As growth slows, we expect the Bank of Canada to begin cutting rates and the yield curve to flatten. This backdrop should support long-dated Government of Canada bonds and the Fund’s positioning.
Chart of the Month
U.S. Consumer Price Index (CPI) Month-Over-Month
Source: Bloomberg
The moderation highlighted by the white arrow surprised some market participants. In our view, weak nominal wage growth and the ongoing ‘no hire, no fire’ labour-market backdrop are key contributors. AI-related investment remains an important source of activity and price pressure in select categories, while inflation elsewhere appears softer. This gives the Federal Reserve greater flexibility to hold rates steady or, if warranted, begin easing.