Two-Faced Data - Views from the North

Ben Reitzes:

Welcome to Views from the North, a Canadian Rates and Macro podcast. This week, I'm joined by Adam Whitlam from BMO's Fixed Income Sales Team. This week's episode is titled Two-Faced Data.

I'm Ben Reitzes, and welcome to Views from the North. Each episode, I will be joined by members of BMO's FICC 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. R-E-I-T-Z-E-S @bmo.com. Your input is valued and greatly appreciated.

Adam, welcome back to the show. It's been four months. I can count on my fingers since you last came here, and well, it's New Year and-

Adam Whitlam:

That feels like five lifetimes ago, those four months.

Ben Reitzes:

Every day is a lifetime for you. That's the secret.

Adam Whitlam:

That's true.

Ben Reitzes:

Adam does a lot of different things here and so, that at times can be taxing. Big Canada next week, so there's lots to talk about, and the data flow over the past, I don't know, count up as long as you want to talk about it, has been very entertaining, and eventful and driven. Pretty big market swings. We got another one today with GDP. And I think from quickly on the dive, I think the bank is pretty straightforward, so there's not much point in dwelling too much on them. But they put the conditional pause in place in January. Everything has really just reinforced that, CPI was on the soft side last week. Not super soft, but soft enough. GDP growth came in flat, which was meaningfully weaker than expected, and so that also argues for the pause there.

And the only thing that's on the other side has been the really big job print, but that's clearly not enough, and we don't even get the next job number till a couple of days after the bank. So it's pretty clear at this point, they're going to be on hold. I guess the question that I would have, let's hear your opinion on this, is are they going to reinforce this conditional pause? Are they going to going to keep that language, or are they going to maybe stress a little bit more that the door is still open to further hikes, given the data flow over the past four to six weeks, and the fact that the market is pricing a bit more for the bank at this point and even more for the Fed?

Adam Whitlam:

I got to think that they're, if I'm the Bank of Canada, if I'm Macklem, I'm scratching my head a little bit to some of the resiliency of the data. But there have been some encouraging signs like you were alluding to. You're getting a little bit both ways. Some items have been a little bit slower, but you've seen persistent strength. I think the concerning thing is, the persistent strength is in sectors like the labor market where if that remains persistently strong, that's just going to provide a feedback loop into higher inflation. Which is just going to provide a wage growth inflation, which is just going to put you right back into a scenario where you're forced to continue raising rates. I think at this point, they're probably going to lean on the narrative of waiting to see the full impact of the data, after the rate hikes that they've put through.

I think a conditional pause is still fair. I mean, you have the impetus in there. It's a conditional pause, so should the data continue to come in strong, they're going to give themselves that flexibility. I think in their inaugural minutes that came out, I would say, I was a little surprised when they were contemplating between zero and 25 at that point. I know from reading those minutes, it didn't seem like it was too serious a contemplation on the zero, the no rate hike camp. It seemed much more heavily skewed from the evidence side toward 25 basis points, but I think the market in general was a little surprised that it was even on the table. So maybe at that point, they were already a little closer to that conditional pause. So I think it would be hard to see them pivot already.

I'm sure they wish they could see the US jobs data before they had to make that decision, but March, we know nothing's going to happen then. And should the labor market in Canada continue to be pretty resilient, I think April could very much be in play. I think the bigger question there is, okay, so if April is a possibility, how much further could we go? We know that terminal in the US has been ticking higher in 2023, and so what's that divergence level look like? How many beeps between the Fed and the Bank of Canada is too much? And so, if we get three hikes from the Fed, three more hikes from the Fed this year in 2023, is that okay for the Bank of Canada to remain on hold? Or does that start to force their hand a little bit and do they start considering 25 basis points, just based on that differential?

Ben Reitzes:

That's where it gets down. So right now, that differential's around 65 to 70 basis points. I think you're probably five to 10 beats too high there at the moment. So that third hike, so if you were to get the Fed going to five and a quarter to five and a half, and the bank's still at 4.50, that's going to be challenging for the Canadian dollar. And then in turn, for the inflation profile for Canada. And as much as Deputy Governor Beaudry talked about the bank being seemingly agnostic to the direction of the Canadian dollar, noting that there are benefits to a weaker Canadian dollar from the production export side, and benefits from a stronger Canadian dollar to consumers who buy imported goods, and that lowers inflation. I just have trouble believing they're that agnostic, and the reality is that a weaker Canadian dollar means higher inflation, and they're battling inflation. So that's got to be the way that they are least comfortable. And so there is a limit there.

And the other way to look at it, and I think this is probably even more important than just the currency, it's like if the Fed continues to raise rates, so the next Fed meeting, it's March, and then May, and then June. If the Fed is still hiking in June, the economy's probably in pretty good shape by then. If the US is in good shape by the middle of the year, Canada's probably okay. And if Canada's still doing okay by mid-year, yeah, rate hikes are certainly, you got to think they're on the table. I mean what the bank wants to see, and we saw that a little bit this morning with the fourth quarter GDP report is a consistent string of below potential GDP growth. And so, that means probably one and a half percent or less growth and they probably prefer the less rather than close to one and a half percent. Potential's in that one and a half to 2% range. We'll see where they reevaluated in April, but it is probably going to be around there, give take.

0% GDP growth is a pretty good step down the path toward narrowing the excess demand in the economy, which is exactly what they want to do. That's how they believe they're going to push inflation back down to 2%. So these are important steps. If you're getting the Fed hiking in June, that means the first and second quarter probably look pretty good, which is at least close to potential, you'd think. Not working down that excess demand as much as the bank wants to see, and probably means a little bit more of an inflation impulse and probably a stronger labor market. So all that stuff, you put that all together, hard to see the bank lagging the Fed all that much. The only exception to that would be if housing takes another huge step down or the higher debt burdens of Canada just cause us to suddenly hit a wall, and things just all of a sudden go off a cliff.

But I don't know if we are going to get a Wiley Coyote type moment, or as we discussed earlier, you noted Thelma and Louise, where we just drive off the cliff. And then we're going for a little bit and then we go straight down, or if it's just going to be a gentle slowdown and we get growth around zero-ish or sub 1% for a few quarters, which is exactly what the doctor ordered and exactly what Macklem ordered. But I don't know yet, and I think that the jury's still out. Data were all over the place, and that's made it really hard to know exactly what's going to come next, but strong job number next week and April is on the table, I think.

Adam Whitlam:

I got to say, the trend I think in Canada and in life in general at this point has been more of the Thelma and Louise variety. I don't know if that's the advent of mobile stock trading platforms and meme stocks, and wildly higher excess spending. Or, maybe it's on demand entertainment, I'm not sure, but everything seems to be, spend until the money is, it's not just gone. It's you are in the hole, you're in the red. And so same with the Canadian market when we're trading, you look at the liquidity in the backs pit. You look at the extremes that we get. We were talking a little bit about some of the inversion that we had in the curve. As we were still hiking rates when last time I was on here, we had M3, M4 backs is inverted by 150 beeps, which we were pounding the table, that made no sense and it's moved a hundred basis points by now, but it's the same thing. Everything gets way over its skis. So I think this data could remain surprisingly resilient and then really drop off hard.

Ben Reitzes:

I'm going to take the other side of that a little bit. I think jobs next week will be bad. I'm very open to being wrong because this is just my gut feeling based on how I read the numbers from January, but I think it was more a lack of firing than strong hiring that drove the January numbers and February is a strong month for hiring. If I'm right and it was lack of firing rather than hiring in January that drove things and Feb won't look nearly as good. I think it should look pretty bad on both sides of the border and that will probably undo, I think, a lot of what we've seen in the market at least over the past six weeks or so. Everything over the past month has really been driven by that job number, the monster job number in the US and then Canada reinforced that and it was like uh oh, rates might need to go way higher.

And so if I'm wrong and again very open to that, if I am wrong, then watch out. You get another big payroll number, another big Canada jobs number just like-

Adam Whitlam:

Look out.

Ben Reitzes:

For everything. I think it's all assets, every asset, every asset class, everything. Rates go bananas higher, the talk will be immediately Bank Canada, talk will be about 5%, Fed talk will be about 6%, sell off across the rate curve globally, I would expect. Risk assets get annihilated on the back of that almost for sure and just watch out. I think as much as you want to see good job growth and everyone being happy and all that stuff, like oh man, that might be not a friendly scenario for markets generally and somewhat punishing I suspect so.

Adam Whitlam:

Well equity risk premiums are sitting in at what? What are PE ratios and S and P are around 18 times, probably comparable to pre .com levels. So maybe it's time for some repricing in equity risk relative to bond yields. The bonds look very attractive at this point.

Ben Reitzes:

They're not that bad. I don't think PEs are as not pre .com type insanity, but they're not cheap. How about that? I think that would be the way to look at them. They're not cheap. I don't know if they fully adjust to where rates are. They might just be pricing a more positive economic backdrop, more positive economic outlook where we don't go into recession and growth just continues on. We get this magical soft landing or no landing or whatever you want to call it and things actually turn out okay, and in that scenario, well maybe they should be here. And then when we actually realize that outcome, stocks then go higher, risk assets then to improve from there. And the resiliency in the stock market and from a Canada perspective in particular, the grinding tightening and provincial spreads has really been notable, really impressive. What else is behind the move in provincial spreads since I'm not going to relate those to the SP500, but I'm sure it's more to it than just that.

Adam Whitlam:

Well yeah, part of it is what we were just talking about, which is just the relentless rise in yields since we've seen since the beginning of February. All ins are more attractive. You have, say take the leveraged buyer or the LDI buyer where discount rates have been rising at the same time as yields have been rising as well. So at this point, funded statuses have been improving. It's time to lock stuff in by actually buying some credit, by buying some rates. So that's been supportive for our market. We've seen a ton of buying into the sell-off and that's been one of the driving factors on provie spreads. We've gone through a period now with a pretty decent drought in supply. We haven't seen a long provincial deal in-

Ben Reitzes:

I can't remember.

Adam Whitlam:

It's been at least two weeks if not longer than that. And so on the back of that we've had consistent buying. A lot of that's been coming through real money demand. A lot of it's been focused in the 20 to 25 year part of the curve and it's been regular, it's been clips of 10 to 15 million, a few different lines every single day from a few different accounts and that's having a real impact. So the dealer community in particular has gotten fairly short some of this 20 to 30 year product and so they've been doing some hedging with some 30 year stuff, but there really isn't much out there to buy. There aren't any clients that have been unloading 30 years that actively and that's been causing the 10s, 30s Ontario box to flatten a lot. We got, I think the wide was probably 25.4, maybe 25 and a half and that was when the Canada curve was, I may think that point is negative four, today it's negative 12 and a half and that credit box is actually flattened and that's just a result of there's just no supply.

I've seen a couple of sellers as we've cracked through that 92 area in long Ontario's. There's been a couple of sellers who have been willing to come in and test the waters, but it just keeps grinding tighter. So until we actually do see one of these issuers tap the market, it's tough to see the market give here. I will say provies are looking a little rich relative to even to corporates. I think provies have been outperforming corporates in the long end for the last week or so, so they're starting to get a little expensive, but now we're down around 91 and a half and unless we get a deal, I just don't see that changing.

Ben Reitzes:

Yeah, no supply is problematic. Yeah, it's the start of budget season, so supply might remain pretty sparse in the near term. We get Alberta and BC this afternoon, it's Tuesday afternoon, different from our regular Wednesday recording date, but those two budgets are out this afternoon. Alberta might say they're never issuing again, I don't know, who knows. BC I'm sure they'll have some issuance. They're expected to go back into deficit but it still won't be a huge issuer either, and Ontario and Quebec are in really good shape and so their budgets are still a couple of weeks away, but there could be nothing between now and then or maybe one or two deals, but not a lot. And if you consider the macro backdrop, so over the past year, inflation's been the story, but what that inflation does is it really inflates nominal GDP, which inflates tax revenues. That does get bled away through higher wage settlements with public sector workers and that thing, but not entirely.

And so the starting point for a lot of these budgets for the coming year is pretty darn good. And so if there's any spending or restraint at all, issuance profiles could be pretty restrained for the next year or so. And so again, that supply side of things might be meaningful and the historical dearth of long end paper in Canada might return. That might be a topic that we start talking about a little bit more after the pandemic changed that. We'll see how that pans out in budget season. We'll get the federal budget as well probably at some point in the next month that can spill in April, but at some point this month seems more likely and we'll see how their issuance profile changes. They give it to us once a year in the debt management strategy, so we'll have to wait and see you on that front.

Well, that brings us to my favorite portion of the show. Adam, what is your current favorite trade idea?

Adam Whitlam:

Huh. Well, I'm relieved that after I think 46 episodes of this podcast, I can finally say I don't hate fives on the curve anymore. So that took a very long time. But yes, we've seen nice backup in twos, fives, tens. I think we're going to see a little bit of a bounce there. I think longer term it actually probably will continue to sell off. I think the belly still looks long term expensive, but we're up against a hundred moving day average in that twos, fives, tens curve. So if you did have that short, which I think in swaps at the low is negative 94, negative 95, I think it's time to take that back, look to reload it maybe at more negative levels. I think as of now we're probably in around minus 76, so I'd look to take that off, especially as we go into the index extension, which we have kicking off tomorrow.

It's not huge, but it's going to be more belly focused in that mids curve, so it should be a net positive for fives. You should see some buying a tens too, but it should be a net positive for fives. Also, the theory has been on mortgage creation as that's been lacking some of the bank Treasuries, we've seen a decent amount of receiving in the belly. I was looking at this over the last couple of months for anybody who reads what I write, looking at this for the last few months and there seems to have been a trend for twos, fives flattening from the start of the month to about the mid of the month for the last few months. So we'll see if that comes back again, if there's any duration replacement in fives. We are also going through bank earnings and so that does open up potential five year bail-in issuance from a couple of different banks and so that would be obviously a net positive for the five-year sector.

So I'd probably look to come out of today and tomorrow long fives on the curve. I still like the front end, still the front end offers a lot of good value. One year OS, as of yesterday, if the algos were really pushing around the backs curve, you got one year OS I think as cheap as 4.83 at one point. I think that's a decent receive. At that point you've got your extra 25 basis points baked into the Bank of Canada, so if you can get something on in that context, anything 4.80ish on a selloff in the front end, I think you receive it. I think that's a worthwhile trade and that's actually higher than where most of the bank gaps are, so I'd look to receive that as well.

Ben Reitzes:

What do you think about the twos, tens curve and the tens, thirties curve here, twos, tens hit negative 100 two weeks ago and there's been lots of pressure in tens since then, and similarly, tens, thirties, that pressure in 10 is flat and tens, thirties really hurt. So what are your thoughts there? Is that move going to continue or is that just a flash in the pan and we're going to revisit the flat levels we saw in twos, tens and go back to zero-ish in tens, thirties.

Adam Whitlam:

I don't think it's a flash in the pan. I think for the time being it's going to continue. I think twos, tens has got more room to go. If anything, I'd say given the flows that are out there broadcast in the market, the re-steepening we've had in twos, tens really hasn't been that drastic and we've actually seen some really good two-way. I mean, there's been some pretty chunky selling going on in the sector, but it's been balanced by an enormous amount of block buying going on in the futures pit. So I think at this point you didn't have a situation where the market was all caught one way or I think you would've seen a much more drastic move in that curve. You've seen a lot more two-way, which to me suggests that you could see it continue to steepen out from here, but I don't necessarily think it's going to be a huge move.

Tens thirties is looking very expensive at this point. It's looking expensive on a cross market basis. We broke through that negative 10 level on the cross market box and have been oscillating more like negative 11 and a half, almost negative 12, even outright. At this point we're neg 13. It feels a little bit like stepping in front of a train because it does seem to be going one direction, but there is a remaining bid for duration out there and there's still the flows, two-way flows in tens. So I think that could keep going.

Ben Reitzes:

And then tens feels like some duration shorts against some curve longs and that they've just offside each other nicely and that's why the move hasn't pit. Maybe as punishing as it usually is for a Canadian market move when we usually everyone gets right over at the same time, tens, thirties for sure. The box, I prefer to fade at neg 20 rather than neg 10. We're like middle of range from the past year or so. So if you were long Canada against the US, flattening Canada against the US, then maybe now's a good time to take that off and then we continue to run here and that tens, thirties freight train keeps going, then you faded it closer to negative 20.

I think that's probably more of a no-brainer, but outright, if you got patience and then no one's going to tap you on the shoulder. It's hard to think that steepening here, tens, thirties at neg 10, 12, 15 is a bad trade if you can just sit in there for a while. I guess we'll leave it there for today. Thank you very much for coming on the show, Mr. Whitlam and I look forward to having you back.

Adam Whitlam:

Thanks so much, Benny, really appreciate it.

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 4:

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