Rates have fallen a few basis points this morning as the Canadian bond market rallied on lower than expected inflation numbers for June. The Consumer Price Index YoY rise of 3.1% was materially lower than the expected 3.6%, while the Core CPI rose 1.3% during June (1.9% expected). The Bank of Canada targets Core CPI growth of 2.0% so the latest reading gives the Bank more wiggle room.

Rates are essentially flat to yesterday’s close, but not for lack of news in the markets.

Generally, risky assets appear to be in favour this morning, evidenced by rallies in the equities and commodities markets. Events influencing markets this morning include a cease-fire in Libya and some positive developments in Japan.

Normally, this increase in risk appetite would exert upward pressure on bond yields, but the offset in the Canada this morning is quite weak inflation numbers from February. Every measure of the CPI was weaker than the market expected, with the key “Core CPI”, which removes the impact of volatile items such as food and energy, was +0.9% year-over-year. Expectations were for a +1.1% increase, while January’s print was +1.4%. The Bank of Canada makes policy decisions with the goal of keeping this metric at around 2.0%.

An early rally in the bond market has faded somewhat. The rally was largely set off by surprising data released overnight that showed the UK economy contracted 0.5% in the 4^th quarter of 2010. The market had been expecting growth of +0.5% so the surprise was quite large.

In Canada, the December inflation numbers released this morning were a bit softer than expected. The CPI was flat vs. November, and up 2.4% year over year (in both cases, 0.1% less than expected by the market), while the Core CPI was -0.3% vs. November (-0.1% exp.) and +1.5% YoY (+1.6% exp.).

Finally, further south we saw evidence that the post-‘homebuyer tax credit’ price of residential real estate has continued trending downward since reaching post-crash highs in June. The November S&P/Case-Shiller Home Price Indices showed that home prices have once again fallen about 3% in the five months from June to November.

Key events for the rest of the week are US-only. New Home Sales, Fed Meeting (Wed); Pending Home Sales, Durable Goods Orders, Initial and Continuing Jobless Claims (Thu); Q4 GDP, Consumer Sentiment (Fri).

Also note that this week, the annual global economic conference in Davos, Switzerland is taking place, and there is likely to be lots of rhetoric and ideas for the market to digest.

There is no US data out this morning, but there is some Tier I Canadian information. Inflation numbers for November were more tame than the market expected: MoM CPI growth was +0.1% (+0.3% exp.), and YoY growth was 2.0% (2.2% exp.). The ‘Core’ CPI numbers similarly fell short of modest expectations. Weaker inflation expectations, all things equal, would help push bond yields lower.

Also, Canadian Retail Sales for October were released at +0.8%, which beat expectations of +0.5%. This sounds reasonably strong but it is noted that MoM Sales growth was negative after stripping out sales at Gasoline Stations [which were up 7.4%]. Also, the September numbers were revised lower.

There is still some material data to come out during the course of this week, including:

US: Existing Home Sales (Wed); Durable Goods Orders, Personal Income / Expenditures, Consumer Sentiment, New Home Sales, Initial and Continuing Jobless Claims (Thu).

Canada: Real GDP – October (Thu)

 A modest rally has taken place in the bond market this morning under the influence of several opposing factors.

Relatively bullish / neutral influences include: The secondary estimate of Q3 GDP growth in the US was +2.5% (up from the preliminary estimate of +2.0% and higher than the consensus figure of +2.4%); in Canada, September Retail Sales Growth of +0.6% slightly missed expectations but were more than offset by upward revisions to the August numbers, while the Canadian CPI suggests that Canadian inflation is ahead of expectations: The Core CPI increased MoM +0.4% due to broad-based price pressures, while the consensus was +0.1%.

On the bearish side: The skirmish involving the Koreas has added to investor caution, and news that Chinese banks may have hit their lending targets for the year and therefore are due for a pause in lending is hurting the global growth story. Finally, the ongoing Irish bailout process continues but wider Irish bond spreads suggest that the investor community remains unconvinced.

It seems that, on balance, the latter set of factors are slightly outweighing the first group this morning, sending yields slightly lower.

While the bond market has rallied a touch this morning, it has been surprisingly muted in the face of some ugly US data. The Consumer Price Index indicates that prices were up 0.2% MoM in October (consensus was +0.3%). Excluding the volatile food and energy component, the ‘core’ CPI was flat (consensus was +0.1%). Additionally, October Housing Starts were 519,000 (consensus 598k), while September Housing Starts were revised downwards from 610k to 588k. Finally, Building Permits issued in October were up by 0.5%, but consensus was for a 3.9% pickup.

Money continues to flow into fixed income securities as doubts about the strength of the US recovery grow, a knock-on of the poor US employment data yesterday as well as other bearish data.

In terms of today’s numbers, word came that the Canadian CPI rose in July (+0.5% MoM, +1.8% YoY) but both of these readings were lower than what had been expected. Additionally, the more relevant Bank of Canada Core CPI was weaker still. A 0.1% increase was expected on a MoM basis but the actual level was -0.1% (the same as in June). YoY, +1.8% was expected but the actual reading was +1.6% (a decline from June’s +1.7%). Whereas inflation was surprising on the upside earlier this year, it is clearly falling short of expectations at present.

Looking ahead to next week, Canadian Retail Sales numbers for July are released on Tuesday.

In the US, key data during the first half of the week includes Existing Home Sales (Tue), Durable Goods, New Home Sales (Wed).