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Playing Catch-Up - Views from the North

FICC Podcasts 07 avril 2022
FICC Podcasts 07 avril 2022


Disponible en anglais seulement

In this episode, Darren Campbell joins me from BMO’s sales desk to discuss the coming Bank of Canada policy meeting, the path for rates & QT, the shape of the yield curve, and his favourite trade ideas.

As always, all feedback welcome.


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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

Speaker 1:

Welcome to Views from the North, a Canadian rates and macro podcast. This week, Darren Campbell joins me from BMO's rate sales desk. This week's episode is titled Playing Catch Up.

Ben Reitzes:

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.reitzes@bmo.com. Your input is valued and greatly appreciated.

Speaker 3:

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

Ben Reitzes:

Hi, Darren. Welcome back to the show. Thanks for joining me again.

Darren Campbell:

Cheers, Ben. Thanks a lot for inviting me back.

Ben Reitzes:

So, next week we get the Bank of Canada, April 13th, we'll get the policy announcement and it is, I guess, hotly anticipated. We could get the first 50 basis point rate hike since 2000, so 22 year gap, almost exactly, I think it was May, 2000 was the last one, so it's been a while inflation still rampant, so the bank might also pull the trigger on quantitative tightening, so little bit there, lots to talk about on that front. And beyond that, let's talk about your views on the curve. I think that's a big topic and we can also touch a little bit on Canada/US. But, let's start with the Bank of Canada with, again, policy announcement coming next week. How do you view the setup to this? Is 50 basis points of slam dunk at this point? Are there any odds of them going 25, is that even remote possibility? And on QT, what are your thoughts there?

Darren Campbell:

So, I think fifty's done. I think that the minutes today now more or less confirm that. There's cover to go 50, I think that's the way the market's set up. I think that there to some of the volatility they've created since last October and so, with the market more or less expecting it, I fully expect that they deliver 50 next week. As far as the curve goes, it feels like it, for the time being, plays second fiddle to the US and the way that the market's interpreting the communication from Brainard and the minutes and everything else. But, having said that, next week will potentially lead to a bit more of a Canadian narrative. And, in fact, the budget tomorrow, as well, in Canada could actually lead to a Canadian narrative.

Darren Campbell:

So, I think at this point in time, the curve generally is a function of, I guess, QT expectations now. I think that up until now, what's been driving it is obviously this expectation around higher rates impacting long term growth, which just helps support the long end, coupled with just very aggressive messaging from the Fed and around the front end and that's been a tough one to fade. You couple that with the fact that you have a lot of market participants that have stepped away, you've got a lot of momentum, CTA style accounts that are really driving things and it's been a one way train. So, really it's only in the last 24 hours that you've started thinking a bit differently around it and some of the concerns what QT actually means and whether or not, the first order responses is just more of a bear steepening.

Darren Campbell:

And, I guess our view is maybe that can play out for the time being, but that ultimately it'll still lead to flattening and call it the fives thirty part of the curve where the belly can maybe continue to get hit as the market digests the thinking around QT, but long end should still remain supported. So, Canada specifically in that context, the curve has lagged that flattening, this is a theme that we've been paying a lot of attention to where the Canadian curve now looks extremely steep still versus the US. It's at its steepest levels outside of a big move around the GFC, this is hovering right around the steepest levels. And so, our original thinking was that it made sense to have gotten to these levels, that you had the Fed really changing the messaging a few weeks ago, very aggressive in all their communication.

Darren Campbell:

And, it wasn't until really week and a half ago when we heard from the Bank of Canada, that it was obvious that they were on the same page and that 50's were on the table and that they were more or less going to play ball. So, that to, us opens up the possibility for the Canadian curve to catch up a little bit to the flattening in the US. And so, it's a trade that we still really like, can be expressed in a number of different ways, but we're focused on the five 10 part of the curve and do expect that the Canadian curve can continue to catch up to the flattening in the US.

Ben Reitzes:

Well, I'm with you on the bank, I think everybody's on board with 50 now, all the domestic banks are calling for 50. The market is 80% priced, as you mentioned, the bank is sensitive to creating unwanted volatility after creating significant volatility last year and so, a little more predictability there does suggest 50. And after the speech from Deputy Governor Kozicki, it seems pretty clear that they're willing to go 50 there. And the Fed's been beating the drum loudly on that. And the minutes it's only just reinforced that they're also ready to go 50. So, the bank going first before the Fed isn't that big of a deal when the Fed's telegraphed its message and it's likely 50 bases point rate hike as it has over the past few weeks or so.

Ben Reitzes:

The QT side, I think, is a little more interesting. I'm not sure that's kind of locked in for sure, but I do expect them to announce QT at this meeting. And, what it would mean is an end of reinvestment buying, so reinvestment would just end at this point and that the bank would stop buying altogether, which would be very welcome, the fact that they're still buying Canada's is somewhat ludicrous. The impact of all that is really the question, the impact of QT's the question. And, it's Wednesday, April 6th, that 3:30, so we just got the Fed minutes and we heard from Brainard yesterday, and the message was QT is coming, it's probably coming pretty quick and it might be a little more aggressive than you think. And the reaction to that's been steepening, the long ends gotten punished, and this morning, or this afternoon, the front end's actually gotten a little bit better.

Ben Reitzes:

And so, as much as it's, and I still think this, but I'm playing devil's advocate here, as much as history tells us when the Fed and the bank are tightening, curves continue to flatten, and I do think they will. There is a chance that the QT becomes aggressive enough that you get a lot more term premium put into to tens and longs, you do see the curve steepened and that sell off prompts the Fed or the bank to back off a little bit from their aggressive tightening and then you get the front end actually rallying and you get kind of a turbocharge steepener. So, I think it's at least something to consider, I don't know if I'd call that the base case at this point, because once we actually get the 50s, the market probably even might price in even more, because inflation's probably not looking to back off in the near term. But, I still think all of this sets up for a pause eventually from the bank and from the Fed, after they get to neutral.

Ben Reitzes:

It's still a ways from now, so things can change a lot between now and then, but that's what makes a lot of sense. And, I think until they get to that point, it's really hard for me to see the curve steepen a lot, even if that kind of one scenario that I painted makes it somewhat possible. For now, though, I think flatter's still going forward. It's just very difficult to see things steepen in a lot. But again, QT is the great unknown, the Fed has never done it this quickly, this aggressively, and the bank's never done it at all. So, we'll see what it brings. One dynamic in all this, and we'll get more information tomorrow on the budget, and you kind of hinted on it, but you didn't get there fully, and partially, because we don't really know, is kind of the issuance profile for this fiscal year.

Ben Reitzes:

Fiscal year starts in Canada on April 1st, so we're already into it, but we don't know what issuance is going to look like for the year yet. And, the one thing we know for sure is there's 180 billion in maturities this year, in this fiscal year for Canada and of those 180, the Bank of Canada owns 85 of those. So, that would be assuming there's no caps on the Bank of Canada's balance sheet runoff. Their balance sheet will shrink by 85 billion Canadas this year and usually when investors have Canadas and they mature, they buy further out the curve, they reinvest those maturities. But since the Bank of Canada's not doing, that means $85 billion in Canadas need to find a home somewhere. So, that the net supply of Canada is this year is going to be probably a record high, depending on how you measure it.

Ben Reitzes:

But, if you account for the fact that the bank's balance sheet shrinkage needs to be absorbed somewhere else, plus the deficit itself, which could be, it'll be tens of billions, how many 50 ish, the fiscal update headed closer to 60, but somewhere in that neighborhood seemed reasonable, you have a lot of Canada bonds to take to down. And so, there are some potentially interesting trade ideas to come out of that. My favorite would be swap spreads, and we've already seen two year and five year swap spreads come down pretty aggressively, there's probably room to go there in 10 year, for sure and maybe the safest way, the lowest beta way to play this would be swap spread curve flattener fives, tens, something like that. When we get into kind of the low teens, or even around 10 basis points, that's still an attractive level historically. There's potentially more to it than that though, Darren. What are your thoughts on swap spreads here? Does my thinking make sense and what flows are we seeing on the swap side?

Darren Campbell:

Yeah. I try not to overthink it too much. Swap spreads pushed up on QE and it makes sense that we should probably be drifting a bit lower as this starts to play out on the QT side. So, definitely bias to be selling swap spreads over the medium term. I think that the piece you put out on Tuesday, trying to frame what some of the numbers could look like tomorrow, was interesting and has been a good sort of conversation starter. I think that if the numbers you're suggesting are close to realistic, then that's definitely going to, I think, turn some heads. I think that is potentially a lot of supply that maybe the market isn't fully set up to be taken down.

Darren Campbell:

I think that if we're talking about a number that's around 240 and 85 billion of buying is sort of unaccounted for then, to me, that suggests pressure on cash and lower swap threats. And so, I think that's the way you want to be leaning. I think that what's helped to support spreads, we've seen pretty steady assets while buying over the last while and I guess our feeling is that has probably topped out for the time being. The needs for banks to be swapping assets, we think, is probably topped out for the time being. And so, that, coupled with the fact that we've seen a material rise higher, that Canada stands out as relatively cheap versus the US, certain parts of the curve and could lead to some received flow from global macro, all these things, I think, point to lower spreads over the medium term.

Darren Campbell:

As far as just trying to think about QT in the US versus Canada, and for that to be a potential driver of the Canada/US spread, who will be more aggressive. You'd think it's probably the US without putting too much thought into it. There's big numbers in the US, it is a bigger percentage of GDP, but when you think about it as a percentage of the overall market, it's lower than in Canada, and so it's not clear. We could get some messaging from the BOC that does suggest they want to be more aggressive with winding things down. So, if that's the case, that's probably the one counter argument to being long Canada versus the US here. Otherwise, we like that trade.

Darren Campbell:

I mean, we think that everything still suggests Canada lags a move to higher yields for the time being. It seems like we're going to see that until we at least get through the first hike, it seems like there's a bit of a buyer's strike at the moment, for good reason. The market's coming your way if you have cash to invest and if you're short, been in flatteners, these are trades that you are likely happy to sit in for the time being. I think that people that are in those trades definitely are interested in when the turning point is and will be very happy to reverse and try to get steepening on, but it doesn't seem like people are at all sort of impatient with that at the moment.

Ben Reitzes:

The thesis that the Fed is going to kind of crater the economy at the end of the day is what it all comes down to, I think, and that's what keeps that flattening story intact. And, as long as people talk about central banks taking until something breaks, it's really hard to see the curve steepen out a lot. I think that comes back to me wanting to see the central banks, both bank and the Fed, both pause before the curve resteepens. We're pricing straight line rate hikes from here in Canada to 3%. What are we? 50 basis points now, we'll be at 3% by April of next year. That is super aggressive and I have lots of trouble believing that we can withstand that.

Ben Reitzes:

I think the US could probably take a slightly higher rates than in Canada, but here, I think once we get to the peak of the last cycle, 175, the bank should at least one see how the economy reacts. Housing is a very vulnerable sector, given what's gone on, and I've said many times, and on the last podcast I talked about home prices going parabolic almost across the country. That's a real issue and there's real downside there and the news leaking out here as we speak that the budget's going to have a lot on housing and then Canada's going to announce a ban on foreign purchases of real estate for two years. So, it appears as though housing will be under pressure, beyond just the rate side of things.

Ben Reitzes:

And so, unless the bank wants to crater that sector, which there's no way they do since it is the biggest asset for oh so many Canadians, there's a limit to how high they want to push rates. And then on top of that, there's just the spending side of things. People have mortgages rates are going to go higher, it's going to cost more. There's a limit to how much money you want to kind of divert away from consumption toward those rate hikes and kind of... Back of the envelope calculation, about 40% of debt in Canada is exposed to floating rates and that's not insignificant. That that means an impact will be fairly large as rates move higher. And so, something definitely to keep in mind, I think for policymakers. And just on the mortgage front, one more thing, talked about swap spreads and one counter argument you could put out there on spreads tightening is bank mortgage flow.

Ben Reitzes:

You can make, I think, a pretty decent argument that mortgages are going to get skewed a little bit back toward fixed versus floating. It's not ironclad, but as rates go up, the discount on variable rates does favorable mortgages does tend to decline a little bit and banks will likely push consumers toward the fixed rate as they actually are a little more favorable, in general and that means more pay flow. And so, that might be one mitigating factor, but I think, at the end of the day, the QT means so much more. And, as you mentioned, if QE meant spreads widened a ton, then QT should reasonably mean that they fall a ton. It's just going to take some time for that whole thing to play out.

Darren Campbell:

Yeah, agreed. And just picking up on your point around the pricing, it's fully priced, I think it's easy now to explain where we are. I think there's been no let up in the communication and nobody really wants to be stepping in front of it until you get the first move. So, can the bank deliver 200 basis points over the next six meetings? I think not. I think that we're going to find something breaks sooner than expected, I think that if you look at the tightening cycle, it was not straight line, it was choppy. And so, I think that front ends are going to settle and the front end is ultimately going to be a great receive. But you do wait for the first move from the BOC. And, I think that, ultimately, stepping in ahead of that makes little sense. There's nobody left really to be fading ahead of that, but I do think it'll be a great receive after we get the first move from the BOC.

Ben Reitzes:

Maybe the second move. They have to back off, so until they at least hint that they're not going to be as aggressive, then it's going to be hard to get people into these trades. Generally, that's not going to look great and liquidity in the market's still not ideal, which makes it even more challenging. So, it will really take off, I guess, once they pause. So, getting in small after the first move makes some sense because the signal will come, eventually. It may come sooner than we think.

Darren Campbell:

Well, I think the right way to play it is you leave a pay position on in the US, and the Fed is four weeks behind, so I think to have that position on to be receiving Canada after the first BOC meeting, leave on a bit of a pay position in the US is probably the right way to be playing that

Ben Reitzes:

That makes good sense, I like that. I guess the time gap between the bank and the Fed is helpful, that's a good way to play it. All right, Darren, I think that wraps the things up for this week. Usually, I'd ask for your trade idea, but I think we've covered it more than enough times. Getting short swap spreads seems like the trade we both favor. Am I correct there?

Darren Campbell:

Like that trade and do obviously still like the idea of a CAD flattener versus the US. I think that can play out in a number of scenarios. So, I like that and I'm with you on swap spreads and I do think you want to be picking spots to the post POC.

Ben Reitzes:

All right, cool. Thanks for coming on this week. And we'll have you go on again soon.

Darren Campbell:

Thanks man.

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:

This podcast has been prepared with the assistance of employees of Bank of Montreal, BMO Nesbitt Burns incorporated and BMO Capital Markets Corporation together BMO, who are involved in fixed income and foreign exchange sales and marketing efforts. Accordingly, it should be considered to be a product of the fixed income and foreign exchange businesses generally, and not a research report that reflects the views of disinterested research analysts. Not withstanding the foregoing, this podcast should not be construed as an offer or the solicitation of an offer to sell or to buy or subscribe for any particular product or services, including, without limitation, any commodities, securities or other financial instruments. We are not soliciting any specific action based on this podcast. It is for the general information of our clients. It does not constitute a recommendation or suggestion that any investment or strategy reference here may be suitable for you.

Speaker 3:

It does not take into account the particular investment objectives, financial conditions or needs of individual clients. Nothing in this podcast constitutes investments, legal, accounting or tax advice or representation that any investment or strategy is suitable or appropriate to your unique circumstances, or otherwise it constitutes an opinion or a recommendation to you. BMO is not providing advice regarding the value or advisability of trading and commodity interests, including futures contracts and commodity options or any other activity, which would cause BMO or any of its affiliates to be considered a commodity trading advisor under the US Commodity Exchange Act. BMO is not undertaking to act as a swab advisor to you, or in your best interest in you, to the extent applicable, we'll rely solely on advice from your qualified independent representative making hedging or trading decisions. This podcast is not be relied upon in substitution for the exercise of independent judgment.

Speaker 3:

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

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