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Special Episode: Global Reserve and Asset Managers Conference Panel - Views from the North

FICC Podcasts 13 mai 2021
FICC Podcasts 13 mai 2021


Disponible en anglais seulement

This week’s special episode comes to you directly from BMO’s 8th Annual Global Reserve and Asset Manager’s Conference, which was held May 4-6. Special guests, Chris Chapman, Managing Director and Portfolio Manager from Manulife Investment Management and Ray Tanveer, Vice President at Healthcare of Ontario Pension Plan joined me and Adam Whitlam, part of BMO’s Toronto-based fixed income sales team, to discuss the Canadian rates and macro backdrop, various inflation scenarios and their favourite trades.


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About Views from the North

BMO’s Canadian Rates Strategist, Ben Reitzes hosts roundtable discussions offering perspectives from strategy, sales and trading on the Canadian rates market and the macroeconomy. 

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Disponible en anglais seulement

Ben Reitzes:

Welcome to Views from the North, a Canadian rates and macro podcast. This week, we're going to do things a little bit differently. Last week, BMO held its annual global reserve and asset managers conference. I was fortunate enough to host a panel on the conference on, aptly named, a Canadian rates and macro panel. The panel included myself as moderator, Chris Chapman from Manulife Investment Management, Ray Tanveer from HOOPP, and Adam Whitlam from Investor Sales at BMO Capital Markets. The panel covered a variety of themes from the Bank of Canada to the federal reserve to rate differentials and inflation. one of my favorite topics. I thought it'd be worthwhile to our listeners to take a listen and see what our panelists had to say about the various topics.

Ben Reitzes:

I'm Ben Reitzes, and welcome to Views From the North. Each episode, I will be joined by members of BMO's FIC, sales, and trading desk to bring you perspectives on the Canadian rates market and the macro economy. We strive to keep this 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, dot, R-E-I-T-Z-E-S, @BMO.com. Your input is valued and greatly appreciated.

Speaker 2:

The views expressed here are those of the participants and not those of BMO Capital Markets, its affiliates, or subsidiaries.

Ben Reitzes:

Good morning everybody. Welcome to the opening panel for today. Welcome to the Canadian rates and macro strategy panel. My name is Benjamin Reitzes, BMO's Canadian rates and macro strategist. I've been with BMO for 15 years, and I'm proud to host today's panel. Joining me today is Ray Tanveer from HOOPP, Chris Chapman from Manual Investment Management, and Adam Whitlam from BMO. I'm going to let these gentlemen introduce themselves. They'll do more justice to themselves than I will. So Ray, why don't you kick us off?

Ray Tanveer:

Yeah, good morning everyone, welcome. I'm Ray Tanveer. I work with HOOPP. I've been there since 2007. I started managing their fixed income and inflation bond portfolios 14 years ago. Prior to that, I was with three of the Canadian banks as a bond derivatives and cash bond prop trader, including BMO Nesbitt Burns, good shop, great shop. I'm also on the HOOPP Asset Mix Committee as well. We look at things beyond fixed income, beyond rates inflation to growth factors, inflation factors, things like that. Another part of my job is to make sure that we generate alpha, or we call it value add for our plan members. Happy to be here.

Chris Chapman:

My name is Chris Chapman. I'm a Portfolio Manager at Manulife Investment Management, PM on a global multi-sector fixed income strategy. And we are running assets for clients globally, looking at really all facets of the markets. It's a fairly unconstrained portfolio. We are looking at rates, credits across emerging markets, developed markets, also actively affects. So I'm happy to be here as well. Thanks.

Ben Reitzes:

Adam.

Adam Whitlam:

Thanks Ben. Thanks very much for having me on this panel today. I am a Director in Investor Sales at BMO Capital Markets. I've been with BMO since 2008. I've had the pleasure of working in our Toronto office for a few years, our New York office for a few years, and then back to Toronto with specialization in rates, swaps, and provincials. So it's a pleasure to be here today with you three esteemed gentlemen.

Ben Reitzes:

All right, thank you. Thanks everyone. You can see that we have three excellent panelists today, will make for an interesting conversation. Let's keep it as conversational as possible. Let's kick things off here. The past year has been among the most eventful and challenging periods, personally and professionally, for many of us, as we've learned to deal with this pandemic. Like any economy, it has been surprisingly resilient after that initial shock, recovering faster than pretty much anyone expected with the help of monetary and fiscal policy. And this past April was particularly eventful in Canada. We had the federal government unveiling their first budget in two years. Bank of Canada took a much more upbeat tone as they taper their QE program.

Ben Reitzes:

And one of the persistent themes, I think, that we've seen over the past number of months and really even longer than that is the aggressive policy path priced for the Bank of Canada relative to the US Federal Reserve. That's despite the US being more advanced in vaccinations and the economy recovering faster. Given the close relationship between the two economies, is it reasonable to expect the Bank of Canada to hike ahead of the Fed as the market now has priced? Ray, why don't we start with you there? And then maybe we'll move to Chris for a US centric perspective.

Ray Tanveer:

Yeah. I think that this has been a very topical conversation in our markets recently. And you mentioned vaccination pace. And I think that there will be a convergence there because the supply of vaccines in the US, much greater than the supply in Canada over the last several months. But there will come a time where that actually converges because there's something called a hesitancy factor in the US where some people are just hesitant to take the vaccine. And that, in order to get herd immunity, I think 75% vaccination rate, it might be by say the end of June. And then it starts to taper off there. Whereas in Canada, we didn't have the supply. The supply is coming. And I think that this latest third wave, including the variants, have tipped the people who were hesitant into the camp of getting the vaccine. So I believe by the mid to late fall, both countries will be at a very similar pace of vaccinations.

Ray Tanveer:

Beyond that we go to different monetary policy frameworks. And I think that there's nuances there. First of all, I think the Bank of Canada mentioned that they were looking at the open gap closing, and it's closing faster than we anticipated a few months ago. The other thing is that they're looking at progress with the economic recovery being well underway. Meanwhile, I think Chair Powell and the Fed have been talking about substantial further progress. They keep using those three words, substantial further progress. They have a new framework now that they kind of launched in Jackson Hole and then incorporated on the September F1C meeting, which is their flexible average inflation targeting framework over the long-term horizon of 2%.

Ray Tanveer:

That was a big change because over the previous 40 years, the Fed would be preemptive and they will anticipate inflation. I think, since 1980, let's just say. But then, in 2020, they formally changed that framework. They're not going to anticipate inflation. They're going to react after they've already seen the 2% for some period of time. And they also want to see a string, they use the word string a lot, a string of data. So I think that was a couple of months ago they used that. We've got a payroll report coming up, maybe we'll get 1.2, 1.3 million jobs on the Friday report. So that'll be part of their string of data.

Ray Tanveer:

And given the divergence in frameworks, the Bank of Canada, obviously, they started tapering. We can speak to that a little bit later on, but they're obviously going to be ending your Q or tapering faster to zero than the Fed. And I think they will be able to launch off and raise rates, all things being equal, probably by the middle part of next year. Sometime next summer, say. Whereas the Fed, I think they may not start tapering until after Jackson Hole. As long as the string of data comes in as they expect it to come in, after Jackson Hole, they start tapering. I think, 10 billion a month, 80 billion per month down to zero. Eight months, and then they think about raising rates maybe at the end of next year, early 2023. Depends upon the evolution of inflation and core PC as well, of course.

Ben Reitzes:

That sounds perfectly reasonable. So you're in the camp at the Bank can go first. Chris, what are your views on that?

Ray Tanveer:

Just one more thing I forgot to mention is that the Bank of Canada has in the past, and even after the great financial crisis, they have independently raised rates as well as lowered them independent of the Fed. They raised 75 beeps, and then they cut 50 beeps when Mark Carney was in there. And then Stephen Poloz.

Ben Reitzes:

For sure. Chris?

Chris Chapman:

Yeah. In a similar camp, can the Bank of Canada hike ahead of the Fed? Yes, they can. I think ultimately as things progress over, say, the next 12 to 18 months, it may end up being close, but I think we can see the Bank of Canada go ahead of the Fed. They've already started to normalize policy with the tapering ahead of the Fed. The Fed right now is still very firmly in the camp of still not even thinking about normalizing policy. They're going to be in that camp for a little while longer. There is going to have to be some sequencing in terms of the tapering process for the Fed. So that would push out, even if you start that process, say, later this year or at least kick off the announcement later this year. So the Fed, clearly right now, the dots are pricing and nothing through 2023. I think that's probably unlikely to be the case. So you'll have to pull forward those expectations, but just given where we stand right now, Bank of Canada probably can go first. The Fed probably wouldn't be following that far behind.

Adam Whitlam:

I agree with both gentlemen, and to your point Chris, like we said, the Bank of Canada had hiked ahead of the Fed back in 2010 coming out of the great financial crisis. That was a very different situation. The US was on the brink of collapse from a financial institutions perspective, and Canada kind of skated by relatively unscathed, and as a representative of how risk framework should be in banks. So it made sense at that time for the Bank of Canada to hike ahead of the Fed. This time around, they had a different situation. A lot of parts of the Canadian economy remain in lockdown. The US has had a much more successful vaccine rollout. Can Canada hike first? Sure. We're a commodity-based economy, and commodities are touching all-time highs. But I think there needs to be some contraction on the divergence of those policies. Should Canada have a hundred basis points of hiked prices in the middle of 2023 when the Fed has 50 basis points? Maybe that's a little too wide. So there should be some compression on that front.

Ben Reitzes:

I think that's probably the better question. And for me, that's my biggest issue with how the market's currently priced. It's not necessarily whether the Bank can go first, because as everyone's mentioned, we've seen that they can. And given what commodity prices are doing, clearly that's disproportionately beneficial to Canada. So that will benefit our economy. But how big can that divergence get? How much further ahead can the Bank get than the Fed? Right now, we have over a hundred basis points priced for the Bank of Canada by the end of '23. And we have maybe-ish, 50-ish basis points in the US, 60 basis points, give or take. Is that a reasonable gap between the two? Is there a limit to how far that can go? I guess the question is how far ahead can the Bank of Canada get from the Fed? And given current market pricing, are there any opportunities there? And Adam, why don't we start with you there?

Adam Whitlam:

Yeah. One trade that I've liked, a lot of my trading desks have liked, has been along Canada, US. It can be tricky on the repo side. Obviously with some of the buybacks that we've seen from the Bank of Canada, there are a lot of issues that are special. CORRA has remained persistently low. We've seen the Bank of Canada increase the SRO rate in an effort to improve that a few times now. Effectively, that might put a floor in on CORRA, but still in bond land it can be a little tricky.

Adam Whitlam:

I think it's in swap land. I think there is some opportunity there, and you can see it if you look at the backs curve. You can see it if you look at, say, bedspreads, looking out to say 2023. You have some fairly large divergence between Canada and the US. And again, looking back at swap spreads, three year in particular stands out to me. Two year swap spreads sitting around 35 basis points, three years sitting around 43 basis points. There's a lot of roll there. So on a cross-market basis, you get a lot of good compression. You get a lot of good carry. If you look at, say, receiving a three year swap in Canada to pay a three year swap in the US, your carry on that as positive 21 basis points. So you get paid to wait.

Adam Whitlam:

And it plays on the theme that, at the moment, market pricing has too much divergence. So whether that means that macro needs to extend potential growth and push the output gap closing a little further, or whether that means other members of the Fed board get on board with earlier rate hikes, it plays on that compression. Another point you look at mortgage debt in Canada. We've had a red hot mortgage housing market, and the Bank is going to do what they tend to kind of cool it off. But as a result, we also have massive amounts of mortgage debt. And so that will in turn, increase the leverage effect by a 25 basis point hike.

Adam Whitlam:

So you might want to go out and start hiking rates as the Bank in Canada, but I think because of the amount of mortgage debt and the sensitivity of those interest rates, it's going to prolong that cycle. You need to do it slowly, or you're going to have a real negative downside reaction. You don't want to have a scenario where you're hiking rates, and three months later you're cutting again. So they need to be careful and slow on that front, which is one of the reasons I like receiving three year swaps in Canada, paying them in the US. And there's other factors. You can look at that from a two year, one year perspective. It's been a bit of a pain trade recently, that has more to do with positioning than anything else. But you look at Friday where we're likely going to get a big jobs print in the US, and a terrible jobs print in Canada, and we're setting ourselves up for some of those trades to perform.

Ben Reitzes:

Chris, what are your thoughts there?

Chris Chapman:

Well, from a cross market perspective, a little bit of a spoiler, I think we're going to talk about it later, but I think from the perspective of looking at opportunities, the currency side looks like it can be interesting for our US investors. We like the Canadian dollar, so we think, Canadian assets, there's still some room to go there. Conversely for Canadian based investors, it's really more about being protective against the risk of the weakening of the US dollar. So for us, when we look at Canada, that's one of the areas that we've been looking at that. From a relative, we're a cash bond player. So when we look at opportunities, we're not looking at the rates market per se the way Adam's described it, but we have found selectively some opportunities in play. US treasury shorts against some Canadian provincial paper. Some of those levels have started to look reasonably interesting at periods of time over the last say, six months or so.

Ben Reitzes:

Ray, Canada, US, thoughts?

Ray Tanveer:

One of the things is how far does Canada diverge from the US? And we've seen this in quantitative using. So for example, the reason why I think the Bank of Canada tapered is because before they started their QE program, they owned about 8% of the Canada government bond market, and they've gotten up to 40%. Had they not tapered, they would've ended up owning maybe 47% of the government of Canada bond market by the end of the year. That's the number I've heard. So they had to taper.

Ray Tanveer:

Meanwhile, I think the Fed had owned About, I would say, roughly 15% of the treasury market. They got it up to 23, 24% ownership of the treasury market. And they kept that around 23% ownership. So the Bank of Canada already had gone way ahead. Had they not tapered, they would own double the amount of the Canada government bond market that the Fed owns of the US treasury. So they overshot. And I think that that had an impact on the 30 year Canada, US spread part of it. But when the taper talk started to come into play in March and all of April, you saw that trade unwound a 30 year part of Canada has underperformed the US. It's also underperformed Aussie. So we've had those trades on. We were along US treasuries and Australian 2051s against Canada as an overlay leverage trade.

Ray Tanveer:

The other thing is that we have been short, the Canadian bond market, to our benchmark. We use derivatives. We use leverage. I think we're a big repo client and reverse repo client of the Bank of Montreal's. So I think you already know that. So we earned all kinds of overlays. The other thing is that, there's something really interesting that's happened, is that there's been a big divergence in inflation break-evens. Obviously it has to do with Fed policy versus the Bank of Canada policy. The Fed is letting the US run hot. So you've got 10 year TIPS break-evens. They went up to like over 2.45%. So almost two and a half. Whereas in Canada, you have longer term RRB break-evens sub 170.

Ray Tanveer:

So if you look at the 30 year spread of break-evens between the two countries, it's at a level where you would normally short TIPS break-evens and RRB break-evens. So that is something that we're looking at. We're long Canadian RRB break-evens because I think they're relatively cheap. Because I said that we were short net to our benchmark, and we monetized some of that, talking about this year. Last year, we sold billions of bonds in March, April, May, October right after the US election as well, all the way into December. And then we continued to sell bonds in January and February. But we're getting to a point where the longer end, when long treasuries got two and a half percent on March the 18th, it became somewhat of a risky asset hedge again for asset managers and pension plans.

Ray Tanveer:

And then when 10 year treasury got to 175 around that same time, March 18th, the curve became somewhat a palliative curve to be involved in carry and roll down in the near to intermediate horizon, absent any kind of rate hike move might happen, say, early next year or the end of this year. So I think there's all kinds of opportunities. But if I was to say, in terms of one to 10, I think Adam knows that we were pretty much a 10 on things like government credit spreads in April last year. I would say we're around a three on that. If we talk about inflation break-evens, we were an eight or nine or 10 last year, and even earlier this year. I think we're like a three out of 10.

Ray Tanveer:

Same thing with carry and roll down. There is opportunity for carry and roll down now. If you look at certain parts of the spread curve in Canada, whether you're talking about 15 to 20 or provincial bonds, or NHAs in the four-year area, or provies in the six, seven, eight-year, nine area, there is now some curve and carry and roll down. But I think you have to be hedged by being short the front end, because when they do see the whites of inflation, and when they do start to really taper in the US, and the Bank of Canada starts to look at hiking rates, you're going to have a flattening of the yield curve. Right now, you can be fine in curve steepeners in certain parts of the yield curve, but then I think you can also put on flatteners, for example, twos, tens. You could be in a flattener. Whereas in sevens, thirties, you can be in a steepener, in the near term to intermediate term horizon.

Ben Reitzes:

Fully on board there. I'd like to stay with the central bank theme here. Do you think that it's time to reevaluate central banking framework and their focus on the 2% inflation target Maybe it's time to adjust to a lower inflation world. If you look at the European Central Bank, the Bank of Japan, they'd be prime examples of central banks that would be willing to bet might never hit their 2% targets on inflation, not on any consistent basis, that's for sure. And we will see demographics deteriorate over the coming decades in North America as well. So it is very possible we kind of trend in their direction as well. Or maybe we should be looking at stuff beyond inflation as well. New Zealand's looked at house prices. Is it time for a change from a central banking perspective? Chris, maybe we can start with you there.

Chris Chapman:

Yeah. And I think it is, but the issue is obviously this is a challenging conversation for central banks to have vis-a-vis communication to the market. You are seeing policy reviews, ECBs in the process of a policy review right now. The Fed obviously had theirs fairly recently. As you mentioned, the RBNZ has had housing specifically explicitly added to the remit in terms of what they're observing. When we talk about the expectations for what are you going to hit in terms of an inflation target level, this 2% level, is that the right level? You look back at what's happened over the history, over the last 25 years, and the US core PCE has averaged about 1.7%. Core inflation for the Eurozone over the last 25 years has been about 1.3%. Japan, obviously, is the stark example where CPIX Fresh Food and Energy you have an average just 0.1% over that same time period, headline CPI at about 0.2.

Chris Chapman:

So I think there's a conversation to be had. It's naturally going to be a bit of a tricky one though. There's obviously sensitivity and concerns about any risk of a perception that you're "giving up" on your inflation target, right? Because obviously deflation would be quite a damaging situation, particularly given debt levels where they are elevated globally. It's something that needs to be considered. I think it's a conversation to be had. It's going to be a slow conversation. Look at the ECB right now targeting close to, but below 2%. I think it's going to be something where you're incrementally looking at, what is the right number? Why is 2% the magic number? It's not necessarily sure that it is. So it is something to think about. It is something to consider.

Chris Chapman:

Because more broadly in developed markets as well, the demographic shifts, those are going to continue. Those are going to continue to weigh. You look at population growth rates. Naturally US, for example, has been trending downward. Japan has been zero or negative since about 2008. The bigger countries within the Eurozone have been either negative, in Italy for example, or marginally positive. Those trends broadly, although I should note Canada, of course, bucking that trend since 2015 with the well-known shift, a bit of a pivot, let's say, versus the US approach to immigration. So there's been a benefit there from a population perspective. But more broadly, those demographic trends aren't going away anyway.

Chris Chapman:

So is this the conversation for this year? No. For next year Probably not. But it is, I think, something that banks have to really start to take into consideration as we move forward over time. Because after a while consistently aiming for the same target that really has been out of reach for an extended period of time, there's going to start to be questions about that. And realistically, why does it have to be 2%, right? It hasn't been over the last two and a half decades in any of these locations, really. And markets have functioned. Life has functioned. Obviously you want to protect against perceptions of risks of deflation, but I think down the road there's a happier medium that that can be reached.

Ben Reitzes:

Ray?

Ray Tanveer:

Yeah. I think I mentioned Jackson Hole in the previous comment. The Fed had been working for two years leading up to Jackson Hole in terms of changing their framework. So they already actually changed their framework. As I mentioned, I think going back to 1980 with Volcker, and then Greenspan and company after that, Ben Bernanke perhaps, the Fed would react ahead of any uptick in inflation. They had experienced the 1970s and the early 80s of quite elevated levels of inflation in relation to the previous century, let's say. And so their mindset was that they wanted to get ahead of it. But I think they changed that last year with their FAIT, flexible average inflation targeting framework. And so that's why, as I said, they're willing to let it run hot to achieve the long-term 2% target because over the last 10 years and change, they've actually under shot 2%.

Ray Tanveer:

So then Treasury Secretary Yellen, same thing. Some people are joking that she's starting her second term as Fed chair. She was on the news yesterday a couple of times, both in and out kind of thing. And I believe that Chair Powell, some of the F1C members, Treasury Secretary Yellen, they believe they have the tools to take care of inflation. But I think one of the biggest risks to everybody is deflation. I don't think they're going to change their framework because they just changed it only like last year officially. As for Japan and Europe, I agree with Chris.

Ben Reitzes:

Cool. In the prior question, I kind of made the assumption that low inflation is a semi-permanent part of the landscape, but what if that's not true? We are starting to see some price pressures emerge. If you're looking at this week's manufacturing ISM, you can read the commentary there. It's all about inflation, lots of articles. I talk about it a lot and all my pieces. I'd like to tackle that expression a little bit differently. Each of you will take a different position. Adam, can you please lay out the argument for a return to low inflation? So pretty much what we've seen for the past decade. So more of the same. Then Ray, maybe lay out your views, which are more of a middle ground. And then Chris, maybe you can play devil's advocate, make the case for higher inflation, though, feel free to provide your base case as well. I'm sure I'll chime out on all of them because I got opinions to spare. Adam, start us off.

Adam Whitlam:

Great. Yeah, thanks Ben. Personally, I love the low inflation argument. I remember doing some client tours with you a few years ago where that was one of the major topics that we were talking about, was low inflation forever. And so the argument there, it's not that dissimilar from what you've been hearing for the last decade. Yes, we're in an environment now where this pandemic is unlike anything that we've seen in our lifetimes. And it's caused a massive supply side shock. Economies globally started to shut down about a year ago on the supply side. And we're still recovering from that. And we had a very rapid response from the government. They had a playbook that had been set up, the great financial crisis, that they were able to kind of implement really quickly. And it kind of led to one of the greatest V-shaped recovery and risk assets that we've ever seen in history, but also massively higher savings rates and large shifts in spending too in fairly quick fashion from service based demand to goods based demand.

Adam Whitlam:

And for anyone that's tried to buy a boat or a pool or a hot tub or an anything, paper towels, in the past year, you can attest to how much that supply side shock has impacted the availability of those goods. So this equilibrium has given rise to higher commodity prices. It's given rise to pent up demand. We're pulling forward pent up demand from future demands. Look at things like the Baltic Dry Index and ISM manufacturing prices are all kind of pushing higher. But as we come out of this, as more countries are vaccinated, as the global supply chains improve, that supply side shock is going to resolve. And the demand side, it may remain high for a while, but as the stimulus slows down, as the helicopter money slows down, so too will the demand side.

Adam Whitlam:

And so when you get through that environment, you get back into a similar situation to what we had for the previous 10 years, which is major technological advances are disinflationary combined with globalization and global supply chains, which are disinflationary. Right now, do we have wage inflation? Of course we do because helicopter money doesn't incentivize work. So you needed to offer higher wages to bring employees back, to get things on board, to satiate the demand. As that helicopter money stops, the supply of labor becomes more available. And additionally, look at the regime change that we had. When Trump was in office in the US, you had a real protectionist economy setup. And with Biden in place, look at where wage inflation was during the Obama years, it was two and a half percent. So as we improve globalization and access to labor in foreign markets as we roll through the pandemic, I think some of that wage inflation pressure will abate.

Adam Whitlam:

And I think you also can't ignore demographics. That's another really important. So look at baby boom generations, have a look at Japan and parts of Europe in the eighties and what happened there was an aging population. On top of that, there was an article in the Wall Street Journal just this morning about birth rates in the US. So in 2020, the fertility rate or the number of children per woman in the US dropped to the lowest level it's ever been. So when you consider how they look at that, and they look at that on births, the pandemic didn't really kick off in the US until March of 2020. So this isn't a pandemic story. This is a fundamental shift in the millennial generation. They're working longer. They're having smaller families. And this is going to continue to have an exacerbated effect on the demographics.

Ben Reitzes:

The bigger picture is still disinflationary. Ray, why don't you give us a quick middle ground, and then we'll head to Chris.

Ray Tanveer:

Yes. Full disclosure, I just wrote a Q1 report for the [inaudible 00:28:45], and I also trade inflation break-evens, which is along the inflation bond or the linker or the RRB or the TIP. And then you take the short position in the nominal bond of that similar maturity, or the opposite way. And in the quarterly report, I said that we expected modest reflation. I even gave a number 2.1 to 2.4% over the intermediate horizon. So kind of very boring middle ground for situation right now. We had bet on reflation last year. I mentioned that we bought break-evens. We also bought some break-evens again earlier this year. But we're now running a three out of 10 on a scale of one to 10 kind of thing in terms of that risk factor. In terms of alpha space, not in terms of beta space.

Ray Tanveer:

We're getting these inflationary pressures. I think the TIPS break-evens, the 10 years are around 240, 245. Can they push the 260, 270? Yeah, they can do that. But because of the things that Adam already mentioned about global big picture demographics, technology, things like that, debt overhang, there's other things too in play, I think. And that is the stimulus checks are going to end sometime, as is QEs are going to end sometime. So if you look at certain economists who are in the deflation camp, they continuously say that, this move up in everything including risk assets has been underpinned by stimulus checks and uber QE. Well, that to us is going to end at some stage. And fiscal stimulus is going to end up having some form of taxes in place. So we're going to get some tax increases down the line.

Ray Tanveer:

And the other thing is about this thing about the globalization, China, US relations. I think they're still going to trade. China and US are still going to trade, and there will still be an element of globalization, which is at the margin disinflationary. So yeah, we'll uptick, but then I think that core inflation will get down. And as I said, the big danger for us is disinflation and deflation. That's not really good for asset markets except for bonds.

Ben Reitzes:

Good points. What's the high inflation?

Chris Chapman:

Yeah. So I guess to play the devil's advocate, and our base case is probably a little bit closer to Ray. I do think we have a period here over the coming months where we know the base effects, but there's a possibility that you see a little bit of a higher push. So to play the devil's advocate case for what could be higher inflation is essentially what of the factors that the market thinks are temporary are not temporary. Speaking a little bit to what Adam's talking about, maybe we need to think about a second derivative in terms of some of those deflationary forces, right? We may not see an end of de-globalization, but how much use have we wrung out of de-globalization? How much further can you continue to off shore and continuously try to find ever cheaper sources of labor? And in tech, how much further productivity developments are able to be wrung out of tech? Again, it's more of a second derivative thing is a slowdown in the rate of deflationary impacts there.

Chris Chapman:

So I think really though, and Ben I think you touched on this on your research piece yesterday, maybe the more important question, at least near term as investors in the market, we have to think about is how prepared is the market for even the tiniest bit of sustained inflation? We don't have to talk about inflation running for five years. Is the market prepared for inflation that exceeds expectations even for the next year to 18 months. And I think that that is potentially the bigger risk. I think the other thing to think about with inflation, like a lot of things, this can sort of feed on itself, right? Inflation could be low because inflation expectations have been low. If you start to get maybe a shock to the top side of that, where inflation, some of these temporary factors run a little bit longer than people are expecting, you can actually start to maybe build in larger cases or larger base cases for expectations of inflation, which then that can be somewhat self-sustaining.

Ben Reitzes:

Yeah. Great points. I guess you made my points. I've been espousing those points. For me, I think that really is the question. If we get three, four, five quarters of three, three and a half percent inflation, how willing is the market to look through that given the uncertainty that that really drives? Can each of you take one minute and give me your top trade idea or investment theme, whichever way you want to cut it? Adam, why don't we start with you?

Adam Whitlam:

Sure. Yeah, as I was kind of talking about before I like some of the Canada, US differentials in the front end. Another trade I think is kind of interesting is again, in the swap market. I like looking at swap spreads. In particular, we're in a season now where five year swap spreads and seasonality, really for across the board, but five year swap spreads in particular, we're in a very favorable, seasonal period where they perform fairly well. 10 year swap spreads, there's an area where we talked about the Bank is increasing their WAM. The issuance in the 10 year sector is now going up to sort of 42%. So that in the medium term should be a net negative for 10 year swap spreads.

Adam Whitlam:

They look low, they come off because of that announcement, but on a constant maturity basis, there may be five or six points off their high. So something like a threes, fives, tens swap spread fly, where you pay the fives, receive the threes, receive the tens. Maybe it's a little tough to put on, but something like that, I think, you take the five block after we get through mortgage pay season and you hold onto a core position in the threes and the tens.

Ben Reitzes:

Chris?

Chris Chapman:

Sure. I touched on this a little bit, I guess, but I'll take the view, and it's maybe not as applicable for Canadian investors, but I know this is a global conference, I'd say Canadian dollar, unhedged Canadian dollar exposures for global investors. We've been believers in CAD strength for over a year, since about March of last year. It's had a great run, but we think there's still room to go there. We're targeting probably 120 in dollar CAD, so there's still some room to move there. Can be an interesting opportunity. You've seen a bit of a shift in the driver of the valuation. Last year it was more of the risk recovery, the oil recovery story. Now it's pivoted a little bit more to the interest rate driver of the story. Bank of Canada's pivot recently has provided a nice tailwind.

Chris Chapman:

And from a positioning perspective, positioning information can be difficult to get clear information about it, but we get sources from a lot of different places. It's not a trade that's very heavily weighted. People really aren't heavily into this trade. So we think this is an opportunity that can continue to have some room to go. For example, for our non-Canadian dollar accounts, we would have Canadian bonds unhedged to pick up that appreciation.

Ben Reitzes:

Ray? Last minute's yours.

Ray Tanveer:

Any on fixed income or rate space, I think, as I said, we were three out of 10 on a lot of stuff, including Canadian break-evens, inflation break-evens, RRB break-evens. Other things short the market, especially in the front part, as we anticipate rate hikes. But the other thing is I think a more convicted trade on the reflation theme is Canadian bank stocks. We like Canadian bank stocks. How's that?

Ben Reitzes:

I'm with all three of you. Long Canadian dollar, short swap spreads, Canadian bank stocks are great, can't deny that point. I'd like to thank all three of you very much for joining me today and joining the panel.

Ray Tanveer:

Thank you very much. Have a nice day.

Adam Whitlam:

Great to see you guys.

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 2:

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Benjamin Reitzes Directeur, spécialiste en stratégie – taux canadiens et macroéconomie

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