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Carnage in Canada - Views from the North

FICC Podcasts 04 novembre 2021
FICC Podcasts 04 novembre 2021


Disponible en anglais seulement

This week, Darren Campbell, BMO’s head of FICC investor sales, joins me to discuss the recent Bank of Canada policy meeting, the resulting market carnage, and where we go from here.

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 Darren Campbell, BMO's Head of FICC Investor Sales. Today's episode is titled, Carnage in Canada. 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 That's Benjamin, dot, R-E-I-T-Z-E-S at 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, its affiliates, or subsidiaries.

Ben Reitzes:                       Darren, welcome to the show. For those who don't know Mr. Darren Campbell, he is the Head of FICC Investor Sales. He spent 10 years in London before coming back here. About three years ago, he did a little stint in Hong Kong as well. So he's got good international experience and solid domestic contacts, and he's always a wealth of knowledge, and clients always enjoy speaking to him. So Darren, welcome to the show.

Darren Campbell:             Thank you very much for the invite, looking forward to it.

Ben Reitzes:                       All right. Let's get right to it. So I think we should start with the Bank of Canada, since they caused some serious problems last week, to say the least, and I'll do a quick synopsis. So heading into the bank, I think expectations were that they really couldn't be any more hawkish than what was priced, and the risk was that they'd be the other way, and clearly that was dead wrong. And given the dislocations in Canada over the past number of months, and really number of weeks in particular, especially in the front end, that really caused a lot of carnage, to say the absolute least. And just look at a chart of Canada two year yields and you'll know exactly what we're talking about. Huge increases in yields, the biggest in decades, biggest one-day increase in two-year yields in decades.

                                                And so, that caused a lot of pain in the market and among market participants. And it just seems as though the bank either didn't care about markets, or was just way more concerned about inflation than, for example, the Fed, who we heard from today. And we'll get to that in a minute, but from my perspective, I think it's really just the Bank of Canada telling the public that they will control inflation. They are cognizant of where inflation is, their target is 2%, they know that, they're telling the public not to get too worried. And if you pay attention to the media, and read the news lately over the past kind of few weeks, the volume on inflation worries has definitely picked up. And so that, I think, is what they were trying to get ahead of, and that's why they came out and sounded more hawkish.

                                                Now, whether that means earlier rate hikes or not, I think, depends as much on the media and that narrative in general, and how the volume kind of goes up or down over the next few months. We'll see. We will get a number of CPI prints between now and then, so that could definitely move the needle. But for now, BMO's call, our base case, is for a July 2022 hike. I think the risk is clearly earlier, and while the market's pressing in nearly six rate hikes by January 2023, I'm reluctant to fade that at this point, even though our base case call is clearly a less aggressive Bank of Canada. Darren, why don't you tell us about how clients interpreted last week's Bank of Canada statement, and NPR, and all that? And maybe some of the broader themes you saw in the flows, or was it all just stop outs?

Darren Campbell:             I think the interpretation was fairly unanimous. I mean, it was clear what the bank was trying to do, they wanted to send a message. There was something that they are looking at, or saw, that they didn't like. And whether or not they got a little over excited and overreacted, in a way, at... Who knows? Who knows what went on behind the scenes, right? But the reality is, there was something that they were seeing, they felt the need to send a very clear message to just calm the nerves of the general public.

                                                And so they did that, and I don't think that they necessarily took into consideration some of the vulnerabilities that may have existed in the market at that point in time. Right? And it was a bit of a perfect storm. You had liquidity already impaired, just given the time of year. You were looking at the Canadian bank year-end on October 31, so liquidity was already suffering. I think that that trade of long Canada-US, of people being long the front end of Canada, it just had already created quite a lot of pains. There were already a number of accounts that were underwater, in sort of stress positions. And then when that came out, it just... It was...

Ben Reitzes:                       Carnage.

Darren Campbell:             Carnage. So, yeah. I mean, now we're in a situation where that's happened. It sort of felt... In light of what we'd heard from the Bank of England, and the way things were drifting with some other central banks, you just wondered whether or not there was, actually, almost a bit of a coordinated sort of thinking around this. And getting in front of it to just sort of calm nerves around, is inflation really transitory, or is this an environment that's really going to be persistent, and stress households longer term? But after the Fed today, and after we've heard from the RBA, clearly that is not the case. Fed very, very relaxed in their stance, and have left themselves max flexibility. You still have a Bank of Canada that is, as far as we know, inclined to be perceived as proactive, as far as keeping expectation under control. So, what does that mean? Does that mean that Canada can actually continue to underperform, perhaps a little bit more, as that narrative plays out, potentially?

                                                I mean, I think that given the wash outs, positioning now is a lot cleaner, but that narrative can potentially persist a little bit further. In which case, it probably sets up for a very optimal entry into a trade that should do very well, we think, over the medium term. To be long... To take advantage of that aggressive pricing in Canada, right? And position for, perhaps, the Fed needing to be a little bit more aggressive than the market's currently pricing. Terminal rate seems very low in the US, and so that's the space to watch, we think. Whether or not now is the time to get in and just go forward again, and be long Canada versus the US, given what we've seen over the last week, or wait and see whether or not that narrative plays out a little bit further, and maybe whether or not there is actually a little bit more on the positional side that needs to get cleaned up. So, that's what I think, in light of what we know now, is the area to be focused on.

Ben Reitzes:                       You bring up a couple of interesting points. So one, I'd highlight that the terminal rate... So just kind of looking three to five years out, because realistically the cycle's not lasting longer than that likely, we have the Bank of Canada priced close to 2%, and that's what's priced into markets right now. And if you look at US dollar OIS, it's something in the 150 to 175 range. So Canada, kind of 30 to 40 plus basis points above the US, from a terminal rate perspective. And go back to the last cycle, the Bank of Canada overnight rates peaked at 175, and the US, it was two and a quarter to two and a half. And that's a pretty material advantage to the US's favor, and thinking that's going to flip this cycle, seems like a bit of a stretch to me. I'm not sure fundamentally why that would be the case, I guess we'll have to wait and see, but that's currently what the market's pricing now. So I very much like looking for a higher terminal rate to be priced into the US.

                                                It's just, especially if you consider that inflation might be a little more persistent, maybe last a little bit longer, the risks are skewed toward a higher rate at the end of the day, in the US. So, maybe that takes time to get priced in, as the Fed is clearly very patient here. And they've shown no inkling of being overly concerned about inflation just yet. But that itself begs a different question. Bank of England yelling for the rooftops, Bank of Canada doing more or less the same, both about inflation, and fears of that. The RBA pulling back on their stimulus, to some extent, even if it was followed by some dovish-ness still, they pulled back a little bit quickly. You have rate hikes elsewhere in the world. Does the Fed know something that everyone else doesn't, or is the Fed just trying to roll the dice here and hope that they're right? And then everyone else is going to be overly aggressive, and they'll be wrong at the end of the day.

Darren Campbell:             I guess only time will tell, absolutely. I mean, they are clearly inclined to wait for what they feel is going to be more relevant data, which I think was the way we were thinking about the Bank of Canada. I think we thought that they were going to wait and get a sense of what the data was going to look like early next year, before they really started to get concerned about whether or not this was, in fact, sort of transitory nature or not. So, yeah. So, do I think that the Fed knows something that we don't know? No. I think that, as we know, they have a dual mandate. They're trying to balance that out as best they can. It seems logical, based on where some of the inflationary pressures are presenting, to wait and see whether or not that does start to subside. So, I think no, and Powell was very honest about that, I think, today.

                                                They absolutely don't know, but based on the information that they have right now, they're clearly ready to, obviously, move forward on the taper front, but not commit at all to the timeline around when they need to start to tighten. So I think in that context, it's got to calm down the thinking a little bit at the BOC, I would think. I just think that that's going to help set the tone, I think, certainly in the US, but just generally. Right? And I think that, if anything, the next time we hear from the bank, A, I think that the markets and the households now understand what the point of that was. That was done very tactically to send that message. Does it actually mean that they intend on hiking that aggressively, as in what's currently priced in the market? It's hard to believe, right? I mean, it really is hard to believe that they can be that aggressive, but again, it's sort of relative to the US. So I think that the trade, ultimately, is a Canada-US position still, right? Where you do need to be protected for, yeah, growth to absolutely start to...

                                                I mean, if growth starts to take off, you're going to be feeling it across North America, and you need to be protected for that. And if inflation actually is not as transitory as we've been, maybe, led to believe up to now, then you're protected. Right? But I think we won't really have a clear picture on that until some of the data, early next year. So now, it's just sort of picking optimal entry points. We've spent a lot of time looking at the long end, Canada long end looks very cheap versus the US, but we think that there's a number of factors behind that. There is... We think a lot of that had to do with some of the unwinds in very crowded, curved steepening in the US. That really helped to drive it. Obviously, a lot of supply concentrated in the long end of Canada, but it is a tough trade, right? It is tough to try and express the view in the long end.

                                                Our bias is to be long Canada versus the US in the long end. We think that the fundamentals support it. The potential for growth and inflation is greater in the US, we think, long term, than in Canada. So, but it is going to be the way that the market's interpreting the central bank stance. Whether or not you look at the Fed today, and sort of say, "You know what? The patience now, ultimately, could lead to them needing to be more aggressive." Which is ultimately more of a policy error, quote, unquote, leading to that kind of flattening in the curve. Who knows, right? And so it's just... It's definitely a tougher trade, whereas the front end makes sense. But to be long Canada 2's versus short, something a little further out the curve in the US, call it three year sector, to express the view, we think makes a lot of sense. We think that this is still a bit of a steepener, call it 2's, 5's, and so that trade takes advantage of both those themes.

Ben Reitzes:                       So I think you might get, actually, a good entry opportunity for that kind of trade in the next two weeks, call it. Canadian CPI will be out in, let's call it two weeks, probably. Don't have the calendar in front of me, but it's got to be in that neighborhood. I'm getting a pretty chunky number for the month over month, again. Again, that's going to cause narrative issues for the bank, I think, pretty significant ones, again. Because the headlines are going to be, "Inflation continues to roar in Canada," some stuff like that, so on and so forth. Is the Bank of Canada behind the curve? You'll hear all that kind of stuff, and you'll hear people stomp their feet about that, I'm pretty sure. So, that might be enough to maybe price in even a bit more, get another kind of leg higher in the front end to Canadian rates, and maybe that gives you an entry opportunity. Because it is still hard for me to see them going six times in the next 14 months, even in the most kind of aggressive inflation scenario.

                                                So I can see a world in which they go in January, I wouldn't roll that out, personally. As much as, maybe, the Fed has come, if you get a couple, two or three, really strong inflation prints, and we're already going to get one almost certainly in October, I could see the bank going couple times, maybe three times in a row, or twice in a row, back to back meetings, or back to back to back meetings, depending on what the Fed's doing, and where the Canadian dollar is, just to kind of get a few rate hikes under their belt. And then, take a lay of the land to see how the market reacts, see how the housing market reacts, see how the economy reacts, maybe wait three months, six months, nine months, 12 months until the next move, but it gives them a bit more breathing room. And it also gives them credibility on the inflation front, that they're going to do what it takes to really push back on inflation. And I think that might be, from my perspective, maybe that's the more likely scenario.

                                                It's hard to see the near term inflation pressures pulling back, and so that just might force the bank's hand, unless they kind of all of a sudden wake up and they sound more like the Fed, because maybe the Fed's right and they're wrong. I don't know. I have some trouble believing that. So, maybe a little bit of patience is needed on those Canada to US trades, but if CPI provides a good entry opportunity, I think that that's well worth it. We're already pretty stretched. So if you kind of go a little further out the curve, again that two year point, that could still work out for you. But again, you might even get a better entry opportunity in January, assuming the Fed stays patient. But the risk there is the same as it is here, that inflation stays stronger for a few more months, and worries pick up a little bit. And then maybe the Fed is forced to taper a bit faster, which then front loads a bit of a few more rate hikes than where we are now.

                                                And I would say, I suspect that's kind of where we're headed, personally. Demand is as big of a problem as supply. I'm happy to show anybody who wants charts on that. That would be wonderful, just reach out to me and ask. Goods demand is through the roof and that's where the inflation's coming. Until that dampens, it's hard to see inflation really pulling back because the supply side's just, arguably, getting worse, if you read some of the commentary out of the ISM. And growth is still really strong, so the only way to slow this thing down is probably on the demand side.

                                                With respect to the long end, Darren mentioned Canada-US 30-year sector. I mean, I'm in agreement there, but that's a tough trade. A former colleague used to call that the widow maker, because he traded for a while and he moved to sales. And it was a difficult trade for him when he was a trader, and when he tried to sell it as a salesman. And so, it is certainly a challenging area. Fundamentally, Canada should be richer than the US. I mean, we should probably trade 25 to 50 basis points through, we're more or less even yield right now. I think it's tough, it's probably something to keep on your radar. And if you get any periods of notable weakness in Canada, then you kind of start to dip into that and use it as a long term trade, and maybe use provies to improve the carry profile, and that can just be something you put in your back pocket.

Darren Campbell:             Yeah. I mean, I think the debate is largely around the supply demand and balance. Canada has always had a bit of a shortage of long supply, and that's always helped to keep the long end of Canada well supported, and richer versus the US. And we've had a lot of supply focused in the long end over the past year, and that has... There's no doubt that that's what's helped to drive that spread to where it is today as well. Now we've peaked, as far as from long supply from the provinces, expecting that to be coming down materially, especially as we get some improved budgets over the near term horizon. And I think that that is going to...

                                                That, in theory, should help to be supporting that Canadian performance from these levels. But again, it is probably a debate around whether or not it's now balanced from that perspective, or whether or not there's perhaps a bit of an oversupply, even in Canada. So I think that that's likely to be a key determinant, but also, it's just the way that these curves are going to be trading on the back of central bank expectation. Whether or not which central bank is more at risk, potentially, of a policy error, or which is likely to be just sort of a bit more aggressive first.

Ben Reitzes:                       Is it also possible that we price in more inflation risk premium? Maybe more... If the Fed is more tolerant of inflation, as they seem to be, even though he said today that current inflation levels are in no way consistent with price stability, but is it possible that the US says, "Well, if you're going to let inflation run at 4 or 5% and not do anything about it, we're going to want a little bit more risk premium on the long end?" Whereas in Canada, if the bank's going to be aggressive about it, then maybe we don't need that premium. And I mean, that kind of comes back to the fundamental argument that inflation generally runs hotter in the US than in Canada. Growth, generally, is stronger in the US than Canada, potential growth. And that is, kind of, in the theoretical determinants of long term rates, which clearly don't always hold. But that's the thesis, or part of the thesis at least, behind that Canada-US trade. I guess we'll wait and see how that evolves over time here.

                                                Let's come back to another theme. We used the word carnage a number of times, and a place where you can really see where the stress is in the Canadian market, is in swap spreads. You look at two year, three year, four year swap spreads, you can see they're super elevated. They're off the highs, but they're still crazy high. And that really just reflects the dislocations that are still present in the Canadian market. And arguably, I think that that's probably a reason why you'd want to wait to put on any of those Canada-US foreign end trades. You don't really want to receive Canada yet, given where those spreads are, because it just reflects that the market still is pretty stressed. And as long as that's the case, you could get outsized moves from, I mean, not big flows necessarily. And that really could run you over, and run you right through your stop pretty quickly. So a big reason to be a little bit more cautious, but also, those swap spreads highlight other opportunities. Darren, you want to give us a little more on that?

Darren Campbell:             Yes. Agreed, there is. There's a lot of stress, and the markets appear broken. This is a new... We've started a new Canadian bank fiscal year. I feel that with the Fed now behind us, that there is a bit more balance coming back into the market. I mean, we've seen a little bit more two-way in front end cash, we've seen a few more accounts willing to step in and receive the front end. And you have to assume that that's going to probably persist. Like I said, now with the Fed out of the way, and a clear understanding of where they sit, I think that it kind of opens the door for more received flow, which was clearly lacking.

Ben Reitzes:                       Well, we get the Bank of England... So for full disclosure, it's Wednesday afternoon, so we're just post-Fed, but we get the Bank of England tomorrow. If they hike, it's back. Carnage is back in Canada, for sure.

Darren Campbell:             Agreed. I think that Canada, in many ways, is probably going to get looked at more in the context of the behavior of the Fed than the Bank of England. Right? Personally, but I think that you're right. Yes, the Bank of England could set us back, but I do think that... I don't know. I think that in light of what we learned today, like I said, I think that things are a little bit more balanced, and we could start to stabilize a little bit. So anyway, what that's done is it's created just some opportunities, I think, to be where front end swaps rates have blown out. It's created an opportunity for any asset swap type accounts to be rolling out, further out the curve. I mean, I think that that's the clearest opportunity. In fairness, we've expected to see more of that, and now with this event risk, or certainly once the Bank of England's passed, that once the event risk is out of the way, we're going to be seeing more of that activity.

                                                You look at any chart and it looks like there's probably seven or eight basis points of alpha in that type of position, rolling out from two, three year sector, out to the five to seven year sector part of the curve, on. So, I'd say that. I mean, I think that other things that we're looking at, it seems... Like I said, I mentioned the provincial budgets. It seems like there's going to be a pretty positive narrative. Spreads are tight, but hard to see, provincial spreads giving up too much ground. They look very rich versus CMBs, for example, but to be going the other way on that trade, I think you really do need to think that there's going to be... That credit's going to be coming under a lot of pressure, and risk assets under pressure on the back of a more aggressive Fed. And I just don't know if we've got that message today at all, right? So it just seems like risk assets can remain supported for a while longer, and should be very supportive for the provincial market.

Ben Reitzes:                       I agree, for now. I think the risk is probably that the Fed changes their tone, but we're not there yet, and we're probably at least a couple meetings away from that, my guess, which would put us into early 20, 22. Looks like that's all the time that we have for today. Darren, thanks very much for joining me. I very much look forward to dragging you into this room again for another episode, at some point in the next few weeks, or months.

Darren Campbell:             Ben, thanks very much for having me. I enjoyed that, and do look forward to joining again in the future. I'd say that, despite a very difficult last week, and October really, one silver lining in all this is that the last few weeks have started to bring things back to normal a little bit. We've been seeing a lot more clients face to face, getting on the road and seeing people, and it's just been fantastic to reconnect. Conversations been very interesting, and we do expect that to continue, and look forward to connecting with as many of our listeners as we can going forward. So, thank you again for the invite.

Ben Reitzes:                       Thanks again, Darren. Thanks for listening to Views from the North, a Canadian rates and macro podcast. I hope you'll join me again for another episode.

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

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