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We're Back! - Views from the North

FICC Podcasts 23 septembre 2021
FICC Podcasts 23 septembre 2021


Disponible en anglais seulement

After taking the summer to recharge, Views from the North is back. This week, Adam Whitlam, part of the Toronto-based fixed income sales team, joins me to discuss the federal election results, recent Bank of Canada policy announcement and the state of the Canadian rates market.


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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, I'm joined by Adam Whitlam, part of the Toronto-based fixed income sales team. We are going to discuss the federal election results. The recent Bank of Canada policy announcement and the state of the Canadian rates market. This week's episode is titled, "We're Back!"

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 the show as interactive as possible by responding directly to questions submitted by our listeners and clients.

Ben Reitzes:

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@benjamin.reitzes@bmo.com. That's Benjamin.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, it's affiliates or subsidiaries.

Ben Reitzes:

Welcome to the show, Adam, once again. You've been on a number of times and I appreciate you taking the time here. It's been a while since we published an episode, but we're back, as the title of the episode suggests. We're going to start this week with the federal election. Adam, I know you voted because you're a good Canadian citizen.

Adam Whitlam:

Of course, I wouldn't miss it.

Ben Reitzes:

Of course. Why don't we start there quickly. I'll go through the results for those who haven't been paying close attention. Then if you have any questions or comments, feel free to chime in, but I think overall the results are pretty much status quo, so there's not too much to talk about.

Ben Reitzes:

Again, from a broader perspective, the election was on September 20th. The results were another Liberal minority with Conservatives winning the second most number of seats. It looks as though the Liberals will be back once again, were supported when necessary by the NDP. Exactly where we were before the election started, and so the policy changes should be minimal.

Ben Reitzes:

The Liberal platform was mostly in their 2021 budget. They did add a few goodies, so there is going to be a little bit more spending, but not enough to really change the outlook materially. We still have to deal with Delta and there are still clearly big supply chain issues that are holding back growth. So, nothing to change any forecast there on the right side, shouldn't be any of that.

Ben Reitzes:

I mean, there was pretty much no market reaction whatsoever to the election. Just because it was status quo one, and again, they've already laid out pretty much all of their promises, and the better macro backdrop more or less offsets any increase in spending. Issuance should stay pretty much as expected as they put out in their budget and the debt management strategy.

Ben Reitzes:

Overall, I mean, really not much to report. Not a terribly exciting election, but I guess that's pretty Canadian of us, isn't it?

Adam Whitlam:

And only $600 million to get the exact same result that we had before the election. When the deficit was a little lower, that might've seemed like a big number, but at this point it's so drastically high that $600 million is just another drop in the bucket. So, why not?

Ben Reitzes:

Why, just a little footnote on the, I don't know, what's it? One, two, three, four, twelve digit budget deficit? Can I count that high?

Adam Whitlam:

I liked that, like you said Ben, a couple more tidbits, a little more Liberal spending. I'm sure you're going to see more teaming up between the Liberals and the NDP on a go-forward basis to get some policy changes through. No talk of how we're ever going to start to repay any of this extra spend, but until we get one of these parties in a majority, that's probably not going to come.

Ben Reitzes:

That's fair. There really is no appetite in the country, and politically, to really restrain spending at this point. It does feel like until there are consequences or some kind of issue from a debt perspective, rates moving up a lot, that that conversation probably isn't going to come up. But I guess that's just where we are for now.

Ben Reitzes:

Oh, well. Let's, let's move along. I don't want to get into too politically charged a conversation here. Adam's already chomping at the bit here.

Adam Whitlam:

Yeah. Don't let my views give away which way my vote went.

Ben Reitzes:

Before we move along, just so we don't get ourselves in any trouble. Well, let's talk about the bank. Couple of weeks ago, I mean, they pretty much kept things right down the middle, just because we were in the middle of an election and there was probably a limit to the amount that they could really give up at the time. But there have been some meaningful changes on the macro front.

Ben Reitzes:

What we've seen is their July growth forecast is pretty significantly outside. They missed the second quarter by a few percentage points. They were looking for 2% annualized growth. They came in at minus 1.1% annualized for Q3. They are forecasting 7.3%. It's still early.

Ben Reitzes:

I mean, we're only going to get July GDP the actual next week, but the flash estimate was minus 0.4, and that puts the third quarter on pace for something closer to 2%. If you want to be generous, you can make it 3% if trade is going to add a bit more to growth, but that's two pretty big misses for growth.

Ben Reitzes:

I guess the question would be then can the Bank of Canada maintain their current tapering pace with that type of GDP miss? I think that's a question the market's going to start to grapple with over the coming weeks. When we get July GDP next week, I think that might be the start of that conversation just because we'll have really a negative starting point no longer penciled in there, but the actual. So, it is going to change things a little bit.

Ben Reitzes:

You had seen the Canadian front end rigid a little bit through that soft data patch. That's pretty much worn off now, and things have stabilized to some extent probably, with the Fed moving one inch closer to tapering, or maybe it was a big step today closer to tapering.

Ben Reitzes:

But that's the path of the market, and I guess, Adam, how are your clients looking at the bank here? Is it just a straight path to taper, and then the rate hike comes at some point next year? Or is there a little bit more uncertainty brewing up there?

Adam Whitlam:

Yeah, I think a lot of the sentiment that I've been hearing is a disconnect between tapering and rate hikes. Whereas, when the Bank of Canada, one of the first banks to actually go and start tapering started, it was really a result of the holdings. Their own holdings of their own borrowing program were so much more massive than the rest of the world that they were in a position where they had to start tapering. They had way too much of their own supply.

Adam Whitlam:

In that regard, is tapering akin to hiking? No, at that point you're simply tapering because you just need to reduce some of those holdings. Does a big GDP miss, which we're almost definitely going to have, as you mentioned, Ben. Does a big GDP miss mean that we're going to have to slow down that pace or re-examine what we're doing in bond tapering? I don't necessarily think so. I think tapering might still be on course. We might still maintain that.

Adam Whitlam:

Does it push back the closing of the output gap? Absolutely. Does it change the path for potential rate hikes? Yes, I think it does, and I think it takes... We've already seen a lot of the takeout from, at one point, we were well priced for mid-2022, early 2022 to get rate hikes started. That's, obviously, now going to be quite a bit later, so I think it does take out some of that likelihood of rate hikes in the first half of next year and maybe pushes it into sort of late 2022 maybe, before we see a first rate hike. But tapering, I'm less convinced.

Ben Reitzes:

I'm right with you there. I think they want to end their asset buying. I think that it's pretty clear from the way they've behaved through the first nine months of the year, that tapering is kind of... They view that as necessary at this point, that the emergency stimulus that's providing is no longer needed.

Ben Reitzes:

Rate hikes are a totally different process and they have a totally different bar to start raising rates. It doesn't mean we're not going to get there, maybe in short order once they're done tapering, but it is a much higher and much different bar to say the least there.

Ben Reitzes:

If you look at market pricing at the moment, there was a lot more price to early '22, a few months ago. But even now, if you look at the June meeting, it's trading, call it 36 and at 36 1/2 basis points, and if you assume CORRA's at 20 bps, you're looking at 16 1/2 basis points of rate X prices. That's a 66% chance by June, which seems pretty aggressive.

Ben Reitzes:

I mean, again, if you consider the GDP miss, and it's pretty hard to shrug that off, you're looking at the Upper Deck closing toward the end of 2022 at the absolute earliest, if not into 2023. There's, again, once I think there's a chance we get some repricing a little bit more on the front end, once we get those GDP numbers, and there's a little bit more clarity on that front.

Ben Reitzes:

I think if you get maybe on the back of today's Fed meeting, or maybe you get a little bit of global positive sentiment and that raises those odds of a rate hike a little bit, and you get a little bit push higher maybe of the April meeting or something else in early 2022. I think that that's probably a decent fate. Because it's going to take something pretty extraordinary at this point, I think, to get the Bank of Canada to move in the first half of 2022.

Ben Reitzes:

Given the supply chain issues that are at play, auto productions under severe stress, and that doesn't look like it's going away anytime soon, it just doesn't seem as though the banks are going to rush a rate hike. Unless you get one, something on growth that's really surprisingly positive, which I think is a bit of a stretch given Delta at this point, and winter coming up. Or inflation, and that's probably the bigger wild card.

Ben Reitzes:

We've had core inflation pick up a lot. We've had headline inflation pick up a lot. The Bank of Canada is more focused on the common component, which is still tucked under 2%, but still the trend is still higher generally. So inflation is maybe is that one area where you could get things moving the needle maybe a little bit quicker for the bank.

Ben Reitzes:

Adam, what are the thoughts out there on inflation? If you look at long bond yields, 176 right now, inflation is not a concern it seems. Is that still, is that the chatter? Or has it faded? Is it gone?

Adam Whitlam:

Yeah, so with regards to inflation, what I've been hearing a lot about is coming out of the US. The transitory camp seems to maybe be getting a little bit of credence. What we've seen from a number of companies have been reporting that hiring intentions have eased up the last little while, particularly in some of the states that have withdrawn some of their pandemic related stimulus.

Adam Whitlam:

That speaks a little bit to average hourly earnings and possibly that's slowing down a bit. In which case, we might see maybe a little bit of the pressure on inflation ease up a little bit. The supply side of the equation has been a little trickier. That seems to continue to be a container ship driven problem. Like the Bank of Canada suggested, that doesn't look like it's going to alleviate any time soon.

Adam Whitlam:

From the client base, I haven't seen a lot of long duration bets here, but I also haven't seen nearly the same number of clients willing to fade our market that we had seen, say, at the start of the summer when a lot of the inflation talk was heating up.

Adam Whitlam:

At this point, the client base doesn't seem to think that we are going to get a near term, big sell off in rates and that, potentially, as more people come back in or look to reenter the workforce that maybe some of the boil does come off of the inflation picture going into the rest of the year. With that in mind, I don't think the market at this point is looking for a big beat down in 30-year rates.

Ben Reitzes:

Fair enough. I'll get to 30-year rates in a second, at least in Canada. I think the inflation story is probably going to be key next year with central banks pretty much on the tapering path right now. Inflation doesn't necessarily really fit into that equation all that much.

Ben Reitzes:

I mean it does to some extent, don't get me wrong, but it's more just the need for the emergency side of things has more or less passed. When that part's over and we're done tapering, then we'll reassess. We'll reassess where the economy is, inflation, so on and so forth, and then they can decide whether they want to be raising rates or not.

Ben Reitzes:

I think that's maybe when things get perhaps a little dicey, probably more so for the Bank of Canada and the Fed because they are solely inflation targeters. If you get this inflation pressure lasting into early next year, and while some of the labor market pressures might be easing in the US a little bit, high rate tensions are still really high. I mean, we really haven't necessarily seen much of a back-off inflation. There's been a little bit, but not huge. One month does not make a trend by any means.

Ben Reitzes:

Next year, I think we might be more challenging from that perspective. You'll have higher inflation and potentially still the economy not being necessarily where the Bank of Canada wants it to be. There could be some challenging dynamics there. But at the end of the day, the growth dynamic does tend to win out, and if the output gap remains open, so the economy still has room to get back to potential, that does argue for a later rate hike from the Bank of Canada.

Ben Reitzes:

One thing you mentioned just now was the long end, and just not a huge interest to fade, or really just not much interest at all in the long end, generally. Something I've noticed over the past, I mean really few weeks, and it's really been a few months in the making, is the persistent cross-market under performance in Canada and longs. We're all the way into the low, mid-single digits through Treasuries. That spreads has been as much as negative 80, or we've been 80 bps or so through in prior years, and even 100 bps in 2019.

Ben Reitzes:

Is there anything in particular you see there? There's been not much interested to buy Canada per se, but any interest in the cross-market aspect of things?

Adam Whitlam:

Yeah. What I think is probably the most notable here is how successful the recent US auctions have been. I mean, we've seen massive indirect sponsorship from these auctions. Some of the largest, the biggest sponsorship levels that we've ever seen. I think that really denotes a strong interest from foreign investors in the US Treasury market. There's still plenty of value in swapping those assets back.

Adam Whitlam:

I think that's one of the reasons you've seen such consistent under performance in Canada is that it's not so much a made in Canada story as it is huge sponsorship in the US Treasury market. That's one of the reasons we've seen the big move in cross-market 30-year spread. We're getting close to multi multi-year cheaps if we can approach flat in 30 or 30-year.

Adam Whitlam:

There is a spike I think, if I recall, to kind of going back to 2017, 2018 when we got a spike to about flat and then quickly retraced. If we can get back there, maybe it's a one-touch, maybe it's not bad for a day trade, but the theme this year certainly has been much more support for the US market.

Ben Reitzes:

You talked about demand for US longs, and we've seen that the 5s30s curve and 10s30s curve flatten notably in the US, more in the US than in Canada, but the theme seems to be flattening. Is that the sentiment going forward, that don't fight that trend for now? Even if inflation is still 4% in Canada and 5% in the US? Curve's still flatter with rate hikes now at least kind of on the horizon, the distant horizon, but still there.

Adam Whitlam:

Well, I don't know about you, but standing in front of a freight train just doesn't seem like a very good idea, even if you think you can stop it.

Ben Reitzes:

That's pretty much my sentiment at this point. It feels like even if the seasonals don't favor duration for the rest of this year, I do think that rates really will push higher at some point. They'll probably do some more in a parallel fashion, and you probably get a little bit of a persistent out-performance in longs, even if you do have rates rising. That could still mean a flatter curve, especially if the economy continues to perform, just the recovery continues as largely expected here.

Ben Reitzes:

Adam, do you see any other opportunities in the Canadian market at the moment?

Adam Whitlam:

I do, actually. You know what? One area, I think, if we're looking at relative value, something that's sticking out on the radar right now is a 5s10s30s swap curve. If you'll have a look at Canada 5s10s30s swap versus the US, we're at a multi-year low at, I mean, I have it as Canada minus the US, so negative 20. But that 20 level is quite important on the charts.

Adam Whitlam:

It's been a level where Canada has looked rather rich for quite some time versus the US, and I think it's probably worth a punt. I think one of the other things that's really notable is that if you look at the same box trade in bond land, it's very different.

Adam Whitlam:

Swaps and bonds have diverged in a really big way. I think it's notable to look at that trade and swap market, see some of the support lines and look at paying Canada in the belly and receding in the US on those 5s10s30s flies.

Ben Reitzes:

Definitely that's a trade the strategy team has on and is consistently looking at it. It hasn't moved a whole lot for the past number of weeks, but you look at that long-term chart and it is clearly an attractive trade at these levels.

Ben Reitzes:

Okay. So let's leave it there for this week, Adam. Thanks for coming back on the show, our triumphant return after a nice summer vacation. Hope everyone is doing well out there, and thanks again for listening.

Adam Whitlam:

Thank you, Ben. Pleasure to be on here.

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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