Decidedly Undecided - Views from the North

Ben Reitzes:

Welcome to Views from the North, a Canadian Rates and Macro podcast. This week I'm joined by Jeff Oland, one of our government of Canada bond traders. This week's episode is titled Decidedly Undecided. I'm Ben Reitzes and you're listening to Views from the North. Each episode I'll be joined by members of BMO's FICC sales and trading team to bring you perspectives on the Canadian rates market and the macroeconomy. We strive to keep the show as interactive as possible by responding directly to questions submitted by our listeners and clients. We value your feedback, so please don't hesitate to reach out with any topics you'd like to hear about. I can be found on Bloomberg or via email at benjamin.reitzes.bmo.com. That's benjamin.R-E-I-T-Z-E-S@bmo.com. Your input is valued and greatly appreciated.

Jeff, welcome back to the show. One of my favorite parts about having Jeff on the show is that I actually end up being the person who gets interviewed, so that makes it more entertaining and I'm sure this episode will be no different. So Jeff, thanks for coming on and appreciate you taking the time.

Jeff Oland:

Very glad to be back.

Ben Reitzes:

Because the Bank of Canada is next week, that's where we're going to start today and the next week's policy meeting, I don't think it's going to be a momentous one in any way. There's no reason to believe the bank is imminently cutting rates. So next week's meeting is not in play, but there have been some good signs here and there, inflation's improving. We're not there yet, but it's improving. Business outlook survey, same, maybe not improving as much, but improving. The economy's actually been better. So maybe that flips the other way, but still there's still an output gap in Canada. So there still should be some disinflationary pressure, and I think the outcome next week is probably marginally more dovish, but only marginally and we're not there yet will be the other message.

And so maybe they start talking about rate cuts. Is that possible that in the press conference maybe Macklin mentions that that's something that they discussed and could be open to in future meetings? That's probably max dovish, I think as dovish as they can get, but I don't think there's going to be anything in this statement like that, so nothing too big. We're still looking for a June cut for now. Admittedly, that takes some pretty darn good inflation prints for the next couple months, but we've got in the past two months, so why not two more? Jeffrey, what are your thoughts?

Jeff Oland:

I would actually like to give the Bank of Canada some plaudits for edging away from forward guidance. I don't love forward guidance. I don't know if this is an opposite policy or not. I mean, I don't read too much into the inner workings of the Bank of Canada, but I do think they have refrained from getting ahead of meetings, or as Pal said, getting close to cutting rates or whatever the line might be. So in the end, I think the market in general has got its head around globally what central banks are going to do in the next six to 12 months, and I think to some extent that's why rate fall has come off so much. It's not 22 or the back end of 21 when we were beginning the cycle and there was a lot of uncertainty with respect to where terminal was going to be or how things were going to look.

So, in general, it really feels to me like the Fed is determined to cut rates this year for whatever the reason, and I think it'll be really difficult for the Bank of Canada not to cut at some point this year, and I think that's more or less what's been priced in the markets. And so at the margin when you're looking for a surprise one way or the other, it just doesn't look like there's a massive trade on either side of that imminently on the horizon. And I feel like that has been the trade for this year, which is picking your spots when little opportunities show themselves, but trying to stay away from the big structural trade because more or less the market is comfortable with the path of policy rate that's been priced in.

Ben Reitzes:

Yeah, that's fair. So I'm going to do a little personal thing here and I'm going to push back a little bit on that forward guidance because it makes people's lives like mine much easier when they tell me what's coming exactly, and then I can't be wrong with the central bank call, but that's okay. I mean, historically the bank is one of the central banks that has surprised on a not irregular basis. I mean, this doesn't happen consistently, but it does happen somewhat regularly with unexpected cuts and unexpected hikes over the past decade or so. So arguably that's what makes me still think June is very much in play because even if you don't get those amazing CPI numbers, if other stuff goes that way, you get some softening in the economy, if you still get decent enough CPI, I mean they could cut.

And one of the other things I left out that I should mention is old core inflation CPIX, that was at 2.1% year over year in February. I mean it's not even going to take a whole lot, but you get two middling inflation reports, it probably goes below 2% and then you're going to hear people yelling about that pretty loud I think, and CPIX has done arguably a really good job. It called the turning point on the upside a little bit quicker and not at the top. It turned a little bit earlier and now it's coming down a little bit faster. So I mean there's good argument to be made that maybe we shouldn't have used the other inflation measures at all. We're not going to go there today, but yeah.

What you said echoes back to what I talked with Darren about a few weeks ago, that there just is not a lot of conviction out there on big macro themes because there just aren't any big macro themes to latch onto it. The curve is still really inverted, sure. Is it going to steepen? Definitely. Do we like steepening? Yeah, but the carry is crushing and because of that and because of the fact that you just really don't know when that turning point's going to come, it's not a trade you can really sit in and you need that catalyst. So what's the catalyst?

Jeff Oland:

Yeah.

Ben Reitzes:

I don't know.

Jeff Oland:

Well, before we get into that, I would add on CAD data in general. I don't know why. It feels a little noisy except for the CPI print seemed to be the most auto-correlated, i.e., the prior print seems to predict the future print a little better than the other data. And I feel like for June, July, maybe September, we've had two "misses" in CPI. We're probably one larger print away from them pushing back to July or ... but I think that's somewhat semantics. There's no big trade there. I mean if you were to come and tell me NCPI is about to inflect higher and actually the next move is a hike or something, that would catch the market off guard. I just don't buy into that narrative necessarily. I wouldn't be so arrogant as to say there's no way that can happen. It could definitely happen, but I'm more comfortable with the path that's been priced in, so I come back to that. I just don't think that there's a major trade.

Even if you gave me the next CPI and it was 0.1 higher and all of a sudden we're talking about July, it's going to reprice to a few basis points. It's not going to be a big change in the game. In terms of what could cause the next big trade? It's funny, I was just thinking on the economy, what are people missing in general on the economy? And we talked about this I think the last time we spoke, maybe the fiscal spending is starting to be a bit of a game changer or maybe we've just had a cyclical upturn because this investment in AI or whatever has actually caused a real CapEx cycle that has filtered into the economy. Certainly the PMIs would indicate there's some little mini cyclical upturn. I think that's now more or less understood.

So looking ahead, I'm at a bit of a loss in some part because I don't understand exactly what has caused this little cyclical upturn. So I guess I put the question to you, how did we go from having these really bad, soft data numbers to where we are today? I had somebody today, actually, I think Smartly mentioned it. It was the pivot by the Fed in December that caused it. I don't know if that's true or not. Maybe it was underway before then, but I don't have a good explanation. So what would yours be?

Ben Reitzes:

Well, rates had already rallied at that point. I mean the Fed softening their tone helped for sure. We were already getting rates moving lower. One pretty reasonable explanation is broader financial market stocks pushing consistently higher. No matter what people think, oh, stocks are really expensive, no, they're not. Well, even if they are, it doesn't matter. They're still going higher. They're going to get more expensive, don't worry. So I mean wealth does matter, and I would argue strongly that income matters a lot, and inflation has slowed despite what the man on the street might want to think. Inflation pressures have come down a lot. Energy price inflation slowed. Energy prices themselves had come down until very recently, food price inflation is slowing sharply. And so most of what you buy has stopped inflating at a rapid rate.

But in a number of cases, wage growth is still pretty strong, and so the real wage growth is an area of strength. I think that's probably underestimated at the moment. And by the same token, the Fed looks at this from their angle and they're like, okay, well, inflation versus policy rates, real policy rates, we also look at real wages and when real wages are rising strongly, that is a pretty good fuel for the economy. The question is whether that continues. The question is, at least on the US side is, are you going to continue to get the type of strong job growth we've seen or is the weakness in the household survey the harbinger of something much worse? I don't know. There's some plausible explanations there about population growth and immigration, but that is a reasonable question.

And you saw the divergence to some extent in the directions for the ISMs in the US this week. You got manufacturing turning up, first positive reading in some time. So maybe some cyclical upturn there, which to some extent I can believe, but services slowing more than expected. They're still positive, but slowing. The services one matters more. I mean there's little debate there, so we'll see where that goes, but that certainly took some of the steam out of the market, I think. The lack of conviction means that we just ebb and flow with the data. And if you get strong data points, then we sell off and we keep selling off until you get a data point the other way.

I wouldn't say that the services ISM was the other way per se, but it wasn't strong enough to continue that narrative. So we'll see what jobs do on Friday on both sides of the border, and that'll probably determine the next, I don't know, 15 to 20 basis points either way. We've been so very range-bound that I'd have to think that it's probably lower at some point in the near future, but 370 is a number I've mentioned in Canadian longs a great number of times only to be wrong oh so many times. But that gap is still there. It hasn't been closed yet, so I'm going to stick with it.

Jeff Oland:

Not only do you have that divergence between the household and the establishment survey, but also GDP and GDI is something people have pointed to, which to me, I think there are two points there. One, I think there just is a certain natural cyclicality to the economy outside of major financial shock. So maybe some of this PMI and it is real genuine economic activity where it does get so depressed, but we had such a major boom that it had come off a lot, but from a very, very high level. If you go from a massive boom to just a little less than a massive boom, it's not necessarily a recession. And so maybe what happened was we had a massive boom, we came off that and now we're having another cyclical turn from higher levels than we're accustomed to after we've had policy tightening. So I guess just in general, there does seem to be cyclicality in the economy beyond what the Fed does and noise in the data.

And then the second point I would make, and I mentioned I'm pretty comfortable that we are going to get a few cuts this year and that the next move is going to be a cut, but I would not rule out, and I think this is something people are forwarding that resonates a lot more with me, the idea that you get a couple cuts and inflation doesn't turn over like people are expecting or it turns back up and then they need to hike. And I think it would be a redux of 2021, 22, a massive increase in vol and I would expect to see a pretty big sell off in that kind of environment.

So I still think there's going to be lots of opportunity to trade and I think just because the next trade isn't so obvious, I mean, I agree with you, I like the steepening, I like the being short Canada-US although maybe we could talk about that in a bit. But none of these things seem like they're just obvious trades that nobody's talking about or nobody likes. So in other words, it just doesn't seem super-duper clear what the next three months is. One question I had for you, and maybe you could just fill everybody in on the provincial budget situation, obviously we've had a lot of provincial budgets out, what does it mean for issuance? What does it mean for the ... Do you extrapolate anything from the results?

Ben Reitzes:

It was largely as expected, I think, on the provincial budget side. It was deterioration almost across the board, which was largely expected. A couple of provinces were better, favorite provinces are still Alberta and New Brunswick. Put that out a couple of weeks ago, that hasn't changed. Their fiscal dynamics are better. Alberta is dependent on oil, admittedly, but unless you're very bearish on oil, their dynamics look pretty good. Broadly, the provinces are going to be net stimulative in the coming year. You have larger deficits and more issuance, and that's the story, again, right across the board pretty much. And for better or worse, that's what they've chosen. And some of that is just due to the fact that the federal government let in one and a quarter million people, and that is a lot of people. And guess what? We didn't have the infrastructure in place to let that many people in. Oh, who would've thunk it?

And so now we need to catch up and that has a cost to it, and so you're seeing provinces, big and small, have very large infrastructure spending and a lot of that doesn't go into the deficit per se. It's "investment," but it does mean more issuance and they need to do it. We live in Toronto and there's no debate that we need plenty of money flowing in for infrastructure because we just don't have enough to support all the people here. And so that's an issue and, yeah, should be supportive of growth for the next maybe few years from that perspective.

The bigger question still remains, what do we get out of the federal government? They've been talking a big game about keeping the deficit relatively steady. We've seen a couple of spending announcements the past couple of days. One food program for a billion over five years, another housing thing, 5 billion over, I don't know how many years. It's the third today at three o'clock, so that leaves 13 more days of potential spending announcements, and you know they're going to milk that for every ounce they can and every dollar they can, and so expect more spending announcements. It's just a question of how they structure them. I suspect it will be structured backloaded in general and they'll try to look fiscally responsible, but that generally just hasn't been the case with this government. There's been more spending than expected more often than not. And if you look at spending over the past year to January, I believe federal expenditures are at $500 billion, which is just a lot of money.

Jeff Oland:

I mean, some of these numbers just blow me away. And so actually I also wanted to ask, maybe it's too soon to be doing this and I hate to be the political guy because it's impossible to trade, but how would you think about another Trump presidency? And in general, how does all this government spending feed into your thinking on Western economies generally?

Ben Reitzes:

I try not to think about it. No. I also try not to think about a Biden presidency, so it works out really well. Geez, it's funny, I just sent in my voter registration for the US. It's actually not as hard as I thought it was. I got to email it in this time. I think I had to mail it last time, I think four or whatever years ago. I can't remember the last time I voted, but it's probably four years ago, easy process. Hopefully it actually works this time.

How do I think about it? I almost think it doesn't matter who wins. Everybody just wants to spend, and whether it's spending through just spending and grants and subsidies or it's spending through lower taxes, either way, there's just more spending and more deficits and more debt. I mean, I'm pretty sure we said this last time, it's like maybe that's what's behind the past 15, 20 years though. You had governments not spending for a decade post financial crisis as they tighten their belts. There was a good amount of stimulus during the crisis and then it was like, okay, that's it, we're done. We don't want to have any fiscal problems, so we're going to tighten our belts pretty much across the board.

 Now it's just like, yeah, let it rip. Oh, we're growing at 5%? Spend some more. Sure, why not? And maybe this is why monetary policy doesn't really matter all that much. I don't know, a good reason why Canada's held in there as well as it has. I still think income growth is a big part of all that too, but government employment is up a lot, so they contributed to income growth. So yeah, I mean it's maybe more impactful than people gave it credit for and sometimes fiscal is slow-moving, but it's big and it clearly makes a big difference and should not be underestimated.

And so I guess my bigger concern would be that this just continues unchecked, that Canada keeps spending, that the US continues to spend ridiculously. As bad as Canada might be, and I could complain all day, don't get me wrong, the US is so much worse. Their deficit is out of control, man, and their issuance is going bananas with it. And so how does that end?

Jeff Oland:

The Hoisington Investment Management Company writes a quarterly letter that I think is very good reading, even if they can go long stretches with having very bad market calls that people like to pick on them for. But in the latest one, they write about the net national savings. So the combined savings amount of the private and public sector and in the US it's negative, which is very unusual outside of a major contract. I think the prior times it really was negative was COVID, the depths of COVID, the GFC and the Great Depression, so they're unusual times. I don't think any of it's good for growth in the long run, but maybe it's sufficient to keep inflation higher in the short run.

Ben Reitzes:

Or maybe it's sufficient for bond investors to say like, no, no more money for you at this rate. I don't trust that you're going to pay me back. I don't trust that we're not going to have four, five, 6% inflation down the road. Term premium, please, more please, more please, more please. I mean it feels like every year that we continue down this road, where that much goes through, when that inflection point is, I'm not even going to try to guess, but it's a tail risk that's just sitting there waiting to explode in our face.

Jeff Oland:

I totally agree and I'm guessing a bit that's why equities are trading so well because it's like you're going to keep lending the government who's spending this amount of money as much as they want at, in the case of Canada, 3.5%? I guess that's pretty bullish. May I ask, what do you like trade wise?

Ben Reitzes:

My views really haven't changed, unfortunately. As you said, the lacking of vision makes a big macro trade really hard, admittedly, and so it is very much about the range trade and just being very nimble. And that's what we've heard from, I mean, right across the board of the client base. The most successful people have been doing that. And so Canada, the US being short in the long end, we're still super rich. I think we're still recovering from the fall. The bonds that were taken down in that period was just so large that the amount of time it will take to recover is still months from where we are now. So we're trading much more orderly now and you can talk more about that, but it seems like things are much cleaner and more normal and just the fear isn't in that market the way that it was.

And then steepening still, I mean, favored, but again, you got to be really tactical about that. I think 530 is just probably headed to zero, but the carry is still pretty challenging there unless you put it on a long time ago. And beyond that, long provie spreads, even though you're going to have a lot of issuance, and you are, I'm not sure it's going to be that much more than last year in Canadian dollar terms, at least in Canadian dollar funding, because you are going to have a lot of the big provinces look at US dollar funding, euro funding, sterling funding, and those markets are just massive. Quebec's three plus billion-dollar US dollar issue last week, they're five year. The fact that they can just do that, you walk in, you do an issue, you raise $3 billion in CAD, you're raising four plus, huge numbers and that's 10% of your needs for the year. You're like, okay, well, clearly I have lots of funding available to me.

And so when that's the case, and it is, if there's any stress on the Canadian market, the provinces can easily just walk down south and be like, hello, give me some money please. And we're good credits on a relative basis. We're cheap on a relative basis compared to a lot of others. And provi, in the long end at least, you look at compared to long utility spreads, they look cheap as well. And so there is some value to be had at some points on the provincial curve, so I think that's valuable.

Jeff Oland:

I totally agree with that. I think two points on that. One, the idea that you can go to the US and do 4 billion in funding, it's funny, sometimes I think often it's competitive with the cost of funds in Canada, but sometimes you can go do it at a concession to your CAD curve and everyone's saying, why would you do that at a concession to your CAD curve? Well, 4 billion is the incremental amount that was putting pressure on my spread. So I just repriced my whole debt stock a couple basis points and that's worth way more than three or four basis points on four yards of five years. So I totally get it. I think it's a good tool for them.

And in general, I would definitely say it appears we're in an environment where risk-taking appetite way outstrips incremental supply on the provi side. I think it would be tempting to say, oh, a bit more issuance, provi spread should be wider or whatever. I just think that that will have its day. I don't think that day is today or in the next six months, so I feel that way too. I feel strong.

Ben Reitzes:

I want to add, so provinces have generally lagged the broader risk move. I think tens are close, but longs especially have lagged, and if there is concern that you're going to have some kind of blow-up, you should be able to hide it in provi. They'll widen also, but they should massively outperform all the other higher beta credits. So I mean that's another way to think about it if there's any concern about the risk environment out there, and we might be nearing some kind of bad event, which I don't think we are, but honestly I don't know. You never know when that black swan's going to hit.

Jeff Oland:

No, totally agree.

Ben Reitzes:

What do you like? How is the long end trading? Why is now different than it was one month ago, two months ago, three months ago, six months ago?

Jeff Oland:

I mean, in all my time in the CAD market, I would say August, part of October last year was the most dislocated I've ever seen anything, and I think CAD can get pretty dislocated. It was a lot of buying and it just takes time for that to heal itself. My sense in general is that there's still probably a little bit of a mismatch between how much is issued in the long end and investor demand, but it's fully reflected in the price and in general, we just aren't seeing the same desire to buy as we had seen in last year, and so much of it is index buying that it can turn on at any time. So that is always a difficult investment thesis when it's subject to somebody hitting a switch and deciding they need to buy a lot of a particular bond.

But I would say because of all the supply we've had, positioning is way better. In January, we came in, Ten's bonds traded I think as steep as minus three, minus three and a half, something like that. And Canada-US cross market may have even had an aid handle at one point and there was a ton of short covering there. Those short coverings haven't really reestablished themselves. So i.e., we've come off those levels, but we're way cheaper and steeper than we were last year and it's been fed in by supply this time, not by people who have discretionary trades on and they intend to take off. So I think holding everything constant, given the information we have right now and the dynamics we have right now, I still think that there's an decent opportunity here.

Ben Reitzes:

An interesting note that in the selloff this week and not the case today, but in the selloff this week, Ten's more often than not lead the way in Canada and you get flattening in Ten's thirties and that just wasn't really the case this week. You didn't get the normal move in Ten's thirties in Canada. And that maybe reflects then what I've been saying, that it just long-term trading as well as they were. And as time goes by, you will see some cheapening, whether that's Ten's thirties steepening or cross market. Either way, I think that that's the way it goes.

Jeff Oland:

Totally, and I think if you're a big money manager and you can't move the boat easily, that can be a more difficult thesis to build your investment around. But for us, when we're sitting in the middle of all these flows, we get to see when the flows change and they just haven't changed for a few months. And so that's how we've been trading it and I think until some part of that equation trades, that's probably how we'll continue to think about it.

Ben Reitzes:

All right, any trades you want to add on here?

Jeff Oland:

No, I think that's it. I mean, I would just add on the, let's say more short-term trading basis this year, the fund managers that we feel are doing better are the ones that have been flexible. The ones that are just trading more short-term dislocations, more short-term flows that they're seeing less those that are wed to major views and it just underscores the importance of understanding your mandate. If you put me in a PM seat and said you have a five-year time horizon or a two-year time horizon to make a trade, then the trades are a lot different than otherwise. But I guess don't, if you have to trade short-term in nature, confuse yourself with somebody with that mandate. Even if all the thesis behind a case like that are totally there and makes sense, it still can be difficult. And I think some of the stopouts we've seen, some of the guys having more difficult years are the ones that are trying to take maybe a two-long time horizon to a market that can have big moves in the short term.

Ben Reitzes:

All right, we'll leave it there. Jeff, thanks for coming on this weekend.

Jeff Oland:

Thanks for having me. It was great.

Ben Reitzes:

I’ll have you in again soon.

Jeff Oland:

Great, thanks.

Ben Reitzes:

Thanks for listening to Views from the North, a Canadian rates and macro podcast. I hope you'll join me again for another episode.

Speaker 3:

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