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Inflation break-evens at multi-year highs and higher nominal yields are putting some upward pressure on real yields in Canada, according to a new report by FTSE Russell.

The firm found first-quarter 2021 performance returns showed a sell-off in government bonds, led by longer U.K., U.S. and Canadian government bonds, as the reflation trade gained momentum. U.K. and Canadian short bonds lost least in Canadian dollars. Short-dated bonds were not as weak, helped by near-zero rates.

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Higher government-bond yields made credit returns negative on three-month returns (apart from Canadian high yield) with losses of up to six per cent, while 12-month returns were much stronger, led by Canadian and euro high-yield credit. Higher government yields dragged returns negative in all Canadian bonds on three-month returns with losses of one per cent to seven per cent, apart from high yield. On 12-month returns, quantitative easing and the risk rally drove returns of up to 20 per cent in credit, led by Canadian high-yield credit.

Top and bottom returns reflect the reflation trade and curve steepening on three-month returns, with long bonds doing worst in Canadian dollars. Long government bonds fell sharply on three-month returns in Canadian dollars, with losses of between 11 per cent and 18 per cent in the US, Eurozone, U.K., Australia and the world government bond index. Only Canadian high-yield credit showed positive returns over the last three months. On 12-month returns, Italian, Canadian and Australasian bonds returned between 10 per cent and 31 per cent, boosted by quantitative easing and currency gains in some cases.

Rising inflation fears and the recent bond market upheaval intensified recovery uncertainties and raised tensions between central bank policy goals and the bond market’s more hawkish expectations, noted the report. Improving recovery prospects drove bond yields higher but stirred anxiety about inflation and U.S. Federal Reserve policy.

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