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Bank of Canada on Deck - Views from the North

FICC Podcasts 02 décembre 2021
FICC Podcasts 02 décembre 2021


Disponible en anglais seulement

This week, Austin Derris, part of BMO’s US-based fixed income sales team, joins me to preview the upcoming Bank of Canada policy announcement, share his insights on the Canadian rates market, along with 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

Ben Reitzes:

Welcome to Views From The North, a Canadian rates and macro podcast. This week, I'm joined by Austin Derris, part of BMO's US-based fixed income sales team. This episode is titled The Bank of Canada's on Deck. 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.

Ben Reitzes:

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.

Speaker 2:

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

Ben Reitzes:

Austin, welcome back to the show. I think this is your third or fourth appearance and it is always a pleasure to have you on. I always enjoy your insights. So welcome back in this pre Bank of Canada podcast.

Austin Derris:

Thanks for having me again, Ben. I must be doing something right or people love me and they keep asking for me. So appreciate it.

Ben Reitzes:

At least I love you, that's really all you need to know.

Austin Derris:

Feeling is mutual.

Ben Reitzes:

What else do you really need in your life? So, I guess the topic du jour, outside of the market going slightly pear shaped of late, but we have the Bank of Canada next week and then we'll get to broader market thoughts on a little bit, but let's start with the bank. And as much as it's going to be very difficult for them to surprise the market the way they did in October, I don't think that's likely on tap. It still is the potential to be an interesting Bank of Canada Policy Meeting.

Ben Reitzes:

There have been a lot of changes to the macro backdrop. We have a new variant that may cause issues, it might make them a little bit more hesitant. We've had more inflation data. We just got the third quarter GDP numbers. And so it makes for a potentially interesting meeting and that's especially the case as we creep ever closer to potential rate hikes. Austin, before I go into my long rant on the Bank of Canada, what are your thoughts ahead of next week's meeting?

Austin Derris:

I'd say the most important thing we should be talking about is obviously when we are getting that first hike. So that's probably the most important thing. We are pricing an aggressive path of hikes next year and that is just what it is at this point, but we have virtually nothing priced for next week, December and we have about 50/50 for January. If January is in play, that's probably the most important thing we're looking for at this point. What do you think?

Ben Reitzes:

Well, what are your thoughts on January? Is it possible?

Austin Derris:

It's possible, yeah. I don't see why not. I mean, I think this whole thing caught me by surprise for sure. The pace of hikes that we have priced again, it's aggressive. I don't see us adding more hikes. We're pricing, I think five hikes in next year, but there is room to pull those hikes forward. So I don't see why it shouldn't be a possibility that January is in play.

Austin Derris:

The other thing putting January in play also changes the dynamics of maybe they go three times in a row. I think we originally, when this whole thing started we're probably thinking every other meeting type thing. And then all of a sudden, we're probably thinking two in a row. And now the question is maybe we're talking three in a row. So I think that's something that should also be on people's radars.

Ben Reitzes:

It's definitely on my radar. I'm on record to saying that Jan is possible. It's going to take something to get there though. I don't think we get there if everything is status quo, if we get a couple inflation prints that are above expected. So the Bank of Canada is looking for 4.8% inflation in the fourth quarter, if it ends up being north of there, which is certainly possible. I mean, look at German CPI that we got, a half a percentage point above expectations. So not impossible we get an above expected print there for the next couple months.

Ben Reitzes:

We also get two job reports and we'll get one of them this Friday and it could be very, very strong. You got the number of jobs supports in Canada from the government and so that could have pushed people to take jobs maybe they weren't willing to previous. And the potential is there, why don't I put it that way? I'd say 50/50 or 40%. Something in that 40 to 50% range for odds on January is reasonable for me until we get more information.

Ben Reitzes:

So I don't mind where that meeting is currently priced, but I'm with you on the aggressiveness or the over aggressiveness maybe of next year and what I mean by that is the total amount of hikes priced. I continue to think that as you mentioned, I think the bank will probably go back to back or back to back to back when they do start eventually lifting rates and whether that's in January or April, I think they definitely move that way.

Ben Reitzes:

And if you at the start of the past few tightening cycles, the bank has always gone in back to back meetings, either two in a row or three in a row since I believe 2000. I looked it up today. And it's something I think along for the past 20 years or so after the last rate cut, when the first rate hike it's back to back or back to back to back. And then they tend to pause. And I think something like that seems a lot more reasonable than what the market has priced and relative to what expectations were previously, which were something along the lines of quarterly rate hikes which probably isn't fast enough if inflation really is worry.

Ben Reitzes:

So you asked the question, when is the first rate hike? So as much as I think January is possible, I think the bank will give us a signal. I don't think they're going to leave us in the dark entirely and completely for when the first rate hike comes. What they've done through the pandemic is provide forward guidance and they provided forward guidance through the April gap and when that's expected to close.

Ben Reitzes:

And in October, they threw a curve ball to put it kindly. And the fact that they move the supply side of the equation and then that's how they pulled forward the closing of the April gap. And that means that it's possible they could do that at any meeting. So that's not an impossible event to occur in January and I think the meeting before that, the meeting before the bank does eventually raise rates, I think we'll get some kind of signal. In 2010, so post-financial crisis during the financial crisis, they put a conditional commitment in place.

Ben Reitzes:

In their April, 2010, statement they note that with recent improvements in the economic outlook and they're talking about that forward guidance, the need for such extraordinary policy is now passing and it is appropriate to begin to lessen the degree of monetary stimulus. And so there's something along the lines of that, I don't know if they fully ditched the forward guidance because it's outcome-based in the April gap closing.

Ben Reitzes:

I don't think they necessarily have to, but they will provide, I think, some kind of signal that rates are poised to move higher likely at the next meeting, assuming things don't get too challenging, which I mean, given the way markets have behaved the past few days is certainly not impossible. And we'll see what Omicron does and how that impacts the outlook. But we don't really know anything about that just yet. So I wouldn't be too panicked at the moment. That makes sense, Austin? Any questions or pushback on my thoughts?

Austin Derris:

No real questions or pushback, I think we agree the most important thing at this point is when we're starting, it's going to give us the most information on how many they can get in and at a quick amount of time because I do think that's probably what we're looking at. Get off zero, which they've done a bunch of times and reassess, and I think that's what they're going to do again.

Ben Reitzes:

And I think something important to happen this with week is Fed Chair Powell sounding more hawkish and saying that they have to at least discuss doubling or increasing the pace of tapering which in turn brings forward potential Fed Rate hikes. Means the bank can maybe get a little bit further away from the Fed in the very short term, maybe that enables the bank to get in those three potential hikes and get policy rates up to one percent even the Fed's still at that zero to 25 basis points. Because the Fed is that much closer to raising rates than maybe you would've thought a few months ago, or even a few weeks ago as inflation is clearly on the mind of the Fed as they follow other global central banks on the march toward Tighter Policy.

Austin Derris:

Yep. And that was after obviously, the Omicron stuff popped up in the first place. So they seemed to be on a path to raising rates as well, albeit according to OIS pricing, much slower pace.

Ben Reitzes:

Definitely slower and the terminal rate is lower. We can get to that in a bit, but you mentioned Omicron and I feel like we have to touch on that even though I'm tired of the pandemic. And I know it's mostly over in the US, but not so in Canada. So why don't I go through my quick thoughts on this? I put it in my piece this week, but I'll just go very quickly in my overview. There's I mean, two potential impacts on growth, I think it's straightforward.

Ben Reitzes:

To you get lockdowns, obviously that's a negative, you've already had travel restrictions in Europe and other places and so that's a negative for travel. You're seeing oil get crushed accordingly. I think that side is pretty straightforward. If next week health officials come out and they say, "Guess what? This is not a problem. Omicron either gives very mild symptoms as preliminary data suggests. They don't really know yet you need more information, but the preliminary data point that way or vaccines are effective, or we can make a vaccine in the next kind of month or two. And really, there's not a big reason to worry." Then this probably all goes back the other way. Oil prices go back up and so on and so forth and maybe I get the green light to start traveling again.

Ben Reitzes:

That's the growth side, I think it's pretty straightforward. Inflation is less straightforward. Usually weaker growth means weaker inflation, but not in this case as we've seen with the pandemic. We can get some more supply chain disruptions, more port disruptions, more factory disruptions and that has the potential and likely would exacerbate a lot of the inflationary pressures that we're seeing and at a minimum lengthen the amount of time that we get this above normal pace of inflation. And that's what Powell is watching, that's what global central bankers are watching as well.

Ben Reitzes:

And so that brings back the stag inflation talk, which I don't agree with given where we are economically, but that talk is there. And that's kind of what markets are betting on when you see the curve flattening hard, the way that it is and it's the Fed reacting to that high inflation and crushing the economy. I'm not a buyer of that myself. I just don't see why the economy can't handle modestly higher rates. We're not talking four or five, 10% interest rates it's one, two, three percent, I mean that's hardly punitive.

Ben Reitzes:

And I know there's bigger debt burdens out there, but keep in mind, who's accumulated those debt burdens over the past 18 months or so through the pandemic. Governments more than anybody else and guess who bought all that debt? Wait, central banks. So that they're not really at risk of defaulting to central banks. I don't think that's a concern at this point. So the debt argument is there. I get it. I don't think it will keep rates as low as they currently are. There is still some upside from where we are.

Austin Derris:

What about the thoughts on if it gets really bad and this Omicron thing does put us in lockdowns? Another bump from stimulus as well, which is something I think should be at least thought about.

Ben Reitzes:

Yeah. I guess one of the things we've learned and Mr. Joel Prussky highlighted this to me earlier today is that fiscal policy is probably more impactful in this kind of situation and QE and that type of stimulus, just inflates asset prices and maybe we don't want to do that anymore. So I mean, that's definitely possible, but we already have such a massive cushion of savings on the household side and throughout North America. I haven't seen data through the rest of the world, but I guess it's something similar through most of the developed world.

Ben Reitzes:

I'm not sure how much stimulus we really need, I guess, support for industries that would be hit hard, definitely. But the type of broad base support we got on the early stages of the pandemic would probably be overkill and I would strongly argue, just reinforce the inflationary pressures we're getting. So it would be that much more are inflationary at the end of the day because it would just reinforce the behavior that we've seen developed through the pandemic, which is lots of goods buying, a shift away from services.

Ben Reitzes:

And I think the longer that lasts the more entrenched that behavior becomes and that means that you're not going to have a shift back towards services from goods consumption and the normalization of consumption that the Fed is looking for and other central banks are looking for might take longer. You'll need production to change. You'll need supply chains to adapt and so it's potentially a more difficult and lengthy process than what policy makers are currently envisioning.

Austin Derris:

I completely agree. I just wanted throw it out there is a probably a low delta targeted type stimulus. But I agree with everything you just said.

Ben Reitzes:

I hope we don't get to that. I'm not sure I can manage another lockdown. I might go mad.

Austin Derris:

I completely agree.

Ben Reitzes:

Okay. Moving on from the bank. Let's talk a little bit about the market here. What we've seen over the past week or so is fear of Omicron driving a broader risk off tone. And you can see it today's Wednesday, December 1st stocks had a good morning, they were up about a percent or so after a pretty week Tuesday and they ended the day down shortly lower, really, and sharply lower from where they were this morning, which is really never a good sign.

Ben Reitzes:

And in that type of environment you tend to see the curve steepen as central banks are quite sensitive to asset prices generally, but that's not the case now as you're seeing again, Powell came out and was more hawkish, so that's keeping front end yield it's higher. And you're seeing that bid further out the curve on, again that policy mistake and the risk off.

Ben Reitzes:

So both of those factors are helping flatten that curve, notably. I guess the question from a curve perspective is whether that continues, is it a one way train flatter? I mean, that seems to be the consensus now which you always got to be a little bit hesitant to follow, especially after the past year has been a consensus crusher. What are your curve thoughts here, Austin?

Austin Derris:

Yeah. I mean, I think it's also important to know we're recording this December 1st and there's obviously coupon reinvestments in Canada which will drive long cash versus the front end or any part else, I should say. So I think that that's also playing into this a little bit, at least on the Canadian side. I will say clients, I speak to on the US side, most people have shifted into the long end either at the expense of the belly or the front end, and that's various different types of mutual funds and real money.

Austin Derris:

So it does seem like most people are agreeing consensus is flatter. It just seems to be happening so early in the cycle that it's something that catches me by surprise. And with how aggressive the front end is priced specifically in Canada I don't see us being able to take a straight shot just flatter and honestly, I would take a stab here at a steepener. I don't know if it's today's business. I think we get the ability to see what the bank has to say next week. I think pulling a hike into January or pulling even more hikes if that's even possible would flatten the curve further. That's obviously a headwind for any steepener.

Austin Derris:

So I don't think it's today's business to initiate anything. I think that could be done after the bank, in case we do get further flattening, but it's something that should definitely be on the radar. I'd be in the steepener camp from here for a short to medium term trade, for sure.

Ben Reitzes:

Okay. I think the way that I'm looking at this is because I'm pretty convinced the bank's going to go two or three times in a row when they do start hiking, I bet you we flatten into that event. And then I think as you get to the third hike when I suspect they announce some kind of pause, just kind of a wait and see then the curve steepens because you'll have the bank probably more than three hikes priced by that point, once they've gone back to back, it'd be my guess. And so then you can get some steepening move after they announced that they're going to pause. In the near term, I don't know, again, those December 1 flows definitely big, December 2 also sizeable.

Ben Reitzes:

We also get can how flows in the middle of the month those are also supportive. And so the flows in December are supportive of flattening. There's also a general lack of issuance on the provincial front through December, more often than not. And that lack of supply on the provincial front in the long end is again, very supportive of duration in Canada. And so it's hard to want to fight this flat in trend in the near term. If we get into January, if the Bank of Canada sounds a little more hawkish even at next week's meeting or maybe they wait until January, then you get a little bit more flattening.

Ben Reitzes:

I would at least look at it again at that point maybe you want to put a steeper on. I agree that we've moved an awful long way in a very short period of time and if you look at 530s in the last cycle, by the time we were at these levels, the bank had already raised rates a couple times, I believe. And so it does seem as though we're ahead of ourselves, but jeez, it's really difficult for me to want to fade that just from a seasonal perspective. The calendar is just a tough time to want to put that steeper on. But once the calendar turns, I think then it'll be time to take a look at this thing and maybe that will be a theme of 2022, maybe we'll get some steepening.

Ben Reitzes:

I think it's a challenge with more hawkish central banks and policy rates likely moving higher, but I wouldn't rule it out, especially if inflation persists even as the economy hangs in there and we get rate hikes. If all those three things occur, the terminal rates that are priced as only a percent and a half of the US, 135-ish in Canada could definitely be marked higher and that would likely weigh on duration a little bit.

Austin Derris:

I will say I appreciate everything you just mentioned about December 1st, December 2nd and obviously the mid-month stuff with CMBs. The extensions are real, that season should probably be respected, but I don't think we should be waiting until the first hike or the second hike or the third hike. We are fully pricing in five rate hikes next year, I think there's room to disappoint on that front.

Austin Derris:

I agree while they get a few in quick and then pull off and wait to see how things transpire I think that there is room for disappointment there. A bigger risk I'd say is a Jan hike just in case it pulls forward, so I will respect that Jan hike. I'll respect the December flows, but I think that's probably when we're looking at the latest to probably initiate something. And hopefully clip some of that carry in the front end, which I think is what it will be, carry.

Ben Reitzes:

Okay. I like that. All right. Well, we will revisit this in January. Maybe I'll bring you back post that January meeting and then we'll see whether we want to put the steeper on or whether we already made that call. We shall definitely see it at that point.

Austin Derris:

That's a deal.

Ben Reitzes:

One topic, a bit of an extension of the risk off talk and something I've talked a lot about, at least in the front end swap spreads. And that's been an area, there's been a lot of dislocation in the swap market and you can see it really in swap spreads and the difficulties the Canadian market has faced over the past quarter or so again, represented very well in swap spreads. But we also seen lately a big pull in 30 year spreads a lot of volatility there, Austin, maybe you can talk about how the swap spread curve has moved and shifted so notably over the past few weeks.

Austin Derris:

Yeah. So Ben, we were talking about this a lot last week with 30-Year spreads seem to be able to tell when there's a crisis or at least an almost crisis. 30-Year spreads had in air pocket last week dropped at least 10 basis points and not enough flow to justify that move. We had seen some real money flatteners, but again, the scope of the move was much larger. And now they're going back up with very little flow to justify widening one to two basis points a day.

Austin Derris:

30-Year spreads are still much tighter than the rest of the spread curve, three year is the peak at over 60. So there are places on the spread curve where you can put on a steepener at an inverted spread curve which makes some sense here as well, either threes fives, threes 10s, or anything past 30s, I would say. I will say liquidity can be challenging in 30-Year spreads. So it's something worth noting.

Ben Reitzes:

Okay. Thanks for that. You know what, we're running short on time here. So why don't we get to your favorite trade idea? It's a challenging market so I'm only going to ask for one and I'm not even going to chime in today, because in two weeks I'm going to put out our 2022 preview and I'll let our audience wait for that to hear my thoughts.

Austin Derris:

Yeah. I'm going to stick in steepener camp and I'm going to stick in the swap camp. I would look at something like threes 10s or fives 10s rate steepener. The spread curve is as negative as it's been since the financial crisis. I think threes 10s spread curve is negative 16 or 17. And I think there's enough carry to justify starting to look at something like that, clips and carry and hopefully be able to peel off some of those hikes if they're not realized next year. The caveat being we might have to wait for a little bit and more clarity about January in my opinion or maybe pay a little January against that even though it's probably pricing in roughly 50/50 considering where Cora is right now. But I'm sticking with steepeners. I'm sticking probably in rates and I think that one makes a lot of sense here.

Ben Reitzes:

Okay. Why don't we leave it there for this week. Austin, thanks for joining me and I hope to have you on again soon.

Austin Derris:

Ben, it was a pleasure.

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:

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. Notwithstanding or 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.

Speaker 2:

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

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