One and Done? - Views from the North

Ben Reitzes:
Welcome to Views from the North, A Canadian rates and macro podcast. This week I'm joined by Sam Buckley, head of BMO's, Government of Canada Trading Desk. This week's episode is titled, One and Done.
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.
Sam, welcome back to the show. It is a new year and, well, things might be a little bit different but so far they've been pretty similar in that the market has remained extremely volatile. So exciting year ahead and welcome to 2023 and let's get right to it.

Sam Buckley:
Thanks a lot Ben. Yeah, obviously it's been a big two and a half weeks of market moves, it's really just been one move really, lowering yields, really kind of a steeper curve for the most part. It's really been a perfect storm, I would say, for the market. A lot of new money waiting to be put to work at kind of higher yields where we ended off the year. We haven't seen yields this attractive in a long time just from an investment standpoint. So I think a lot of accounts and even I would say retail investors too, although that's not really what's driving this, would want to put some money to work in fixed income.
But I would say the overall theme of kind of investment positioning from talking to accounts is more kind of looking for higher yields, steeper curves this year. So there might have been a bit of positioning issue to start the year and then we have had a bit of weaker data come through. So I think kind of a perfect storm of little bit weaker data positioning and new money being put to work in fixed income all kind of brought us to where we are today.

Ben Reitzes:
Violent rally. Consistent.

Sam Buckley:
Yeah, very violent rally, consistent. I mean definitely steeper curves too, which kind of says that central banks are the next move is cuts and that's definitely what we're seeing in the front part of the curve. Yeah, I think generally what we're seeing though is we're not seeing buying of fixed income. I mean generally we're seeing, especially this week, I would say definitely this week we're seeing selling of fixed income that would say investors are probably thinking this rally's gone a bit too far given what was on tap. Which no one knows, but generally nothing happens in a straight line and this has been a very, very straight line, lowering yield over the last two and a half weeks.

Ben Reitzes:
So what slows this down? We had another round a weaker data today, it's Wednesday. Out of the US retail sales were soft, industrial production was soft. I guess we don't necessarily see new money flowing in at the pace that we've seen so far this year. So maybe that ebbs a little bit and positioning's probably cleaner. You have to think.

Sam Buckley:
Yeah, I think positioning's definitely cleaner. I would think that what really stops us, I mean that was your question, it's not central bank talk. I think the central banks, especially the Fed has been kind of trying to talk back the market pricing for cuts and the inversion of the curve for a while and the market really hasn't seemed to listen. So now we're getting to the conversation where is the Fed going to get pushed by the market into doing something a little bit sooner than they wanted to. And I mean I think you kind of look back over the last, I don't know, 15 years or so and that's generally been the case. The Fed has generally followed the market to some extent, but I mean there's a lot of wood chop between now and when we're starting to price cuts and so nothing moves in a straight line as mentioned earlier.

So I think that we could definitely get some improvement data, whether that's employment data, it seems like CPI is definitely going to be in a weakening trend. But if the central banks continue to hike rates or at least talk about hiking rates or talking about not cutting rates, there's only so far that we can really push this I would imagine because I mean you're really starting to bleed into quite a bit of negative carry too in some of these positions. So I think that's definitely something to watch out for. We have to Bank of Canada next week and I mean definitely I think the price movement has kind of spawned the narrative that maybe they're not going to go and there's definitely been some commentary around that. I still think that the data's been strong enough to warrant 25 basis points. After that, who knows? I would guess probably a long hold. My call would be probably into the fall, see what happens given the talk around what to expect next and letting the hikes work their way through the economy. But again, we have no idea how they're really going to work, but my base case is hike 25 basis points for next week and then on hold for, call it, till the meeting in September.

Ben Reitzes:
All right. Well, that's the house here as well on my view too. 25 basis points next week then on hold we have through the rest of this year and until the fall I think is a reasonable point to kind of think that they might start to reevaluate either way for that matter. If inflation stays stickier at that point it might become clearer that 4.5% not enough if you really want to get inflation back down to 2%. Or alternatively maybe the economy tanks between now and then they need to start cutting rates. So that's probably the earliest you see them really realizing that and wanting to start to go the other way. And the math on inflation tells you that you can't really get low enough on inflation until Q4 unless things really fall apart in an awful hurry. So that that's the earliest possible point at which they could start moving rates slower. But yeah, I think you're right on.
It's interesting that the market narrative has changed so quickly. The fundamentals, nothing's changed. The employment was still 100,000 earlier this month. CPI was still really strong earlier this week and the business outlook survey wasn't all that bad. I mean it's softened for sure, there's no debating that. But sales growth still expected to be positive and employment growth positive and investment growth positive, all that stuff still on the plus side. No sign of recession from there. Even if the respondents in the survey thought there'd be recession, I don't think any of them are treating their business that way at this point in time. So no real sign of a big reckoning on the economy front just yet. So I don't really know what's changed in the past couple days to mark down policy expectations over the next whatever, weeks and months, but they've done that still. We're still at 25 basis points.

The messaging I think that they deliver is that while they're probably not going to raise further, that's the direction they'll err in and they will keep more hikes on the table even if the market clearly does not think that, and that could impact market pricing. We have just over 4.5% priced into March, April, May, June area that could get pushed a little bit higher because all it would take is really just a month of decent data and then they have to go again or something along those lines. Even if the bar to hike after next week is probably even higher, that's where the risks are. The risk of a near term cut is pretty much zero. And so you probably need to price in at least some odds of rate hikes. So I think you're right it's going to be challenging to continue to rally given the amount of cuts and the aggressive pace of cuts that are in the market.

It's almost as if the market's pricing some odds of an emergency 200 basis points, end of the world type scenario happening in the next whatever, 12-ish, 15 months or something like that, rather than 25 basis points every meeting from October out, which is more or less what we have now. So it's in interesting days for the market. So I guess we'll kind of wait and see where things pan out and how the Bank really plays things next week.

And there's one interesting add-on to the Bank meeting that easy to forget because it's new, we'll get minutes two weeks after the policy announcement. So, the language around that's going to be interesting because we haven't had it and they haven't really given us all that much, but we will see how much more detail we get out of them. And maybe it opens the door to talk about eventual ray cuts or who knows and I guess we'll have to wait and see on that front, but an extra interesting wrinkle that we need to watch out for with the policy statement, monetary policy report and now minutes as well.

Sam Buckley:
Yeah, I totally agree, Ben. I mean I think I would say the front page of the paper worry around inflation is still very much there, although it's going away. Still high. I think they want to mean their job is to fight inflation and I do think they're worried about that kind of front page of the paper, rents are too high, groceries are too high, my bills are too high in general. And I mean let's not forget we've had a huge housing rally, there's still a lot of equity in people's homes despite higher interest rates and it is taking a while to filter through to all the mortgage payers, whether people had fixed rate mortgages that they need to renew at some varying points in time and whether they are in variables and they're just different banks have different structures in terms of how they actually pass on that to consumers.

So I mean I think the longer we go at these levels without having huge data cratering, I mean I think people are going to learn to live with higher payments. Let's not forget we've had decent wage gains as well and I'm sure there's more wage gains to come just given the mismatch in the employment data that we've seen and what we're seeing in the US too. So I think there's still a lot of wood chop and I think that probably the aggressive hikes that we're seeing, not sure if they come to fruition as quickly as the market, I would say that's probably the risk. They do not come to fruition as quickly as the market's saying, maybe they keep getting pushed out, they keep getting pushed out-

Ben Reitzes:
The cuts.

Sam Buckley:
The cuts, sorry, the cuts. But yeah, I think that there's definitely still a lot of wood to chop on inflation.

Ben Reitzes:
Yeah, that's really all it comes down to as inflation just isn't there yet and the drivers of inflation aren't there yet either and that primarily I think is the labor market and things have just remained very tight there both sides of the border and there really no signs yet that things are slowing. A lot of people say labor market's a lagging indicator, you look at it over time it's more of a coincident indicator than a lagging indicator. So I'm not quite convinced there, maybe the unemployment rate lags a bit, but the job numbers themselves tend to move pretty well with activity.

Sam Buckley:
And equity markets still are very strong too. I mean a lot of people have left the workforce in that kind of 55 plus area and they're not coming back as long as the S&P is still at 4,000. I mean get back to 2,700, probably have a different conversation, but as long as people still have the equity that it's been created for them in the last three years, I think that it's going to be tricky to get that participation rate where you need to get it to for the math to work out on the employment rate.

Ben Reitzes:
So that begs an interesting question. Stocks are in pretty good shape. I mean they're down today but pretty decent shape. Spreads, credit spreads, relatively tight. I mean they've been tighter, they're not crazy tight, but they're in no way not cheap in the least. And rates have rallied a ton. Rates are rallying based on expectations of rate cuts, which either mean inflation creators or the economy creators or both or something along those lines. But if that happens, how do credit spreads hold in? How do stocks hold in? The, I guess, contradiction there between risk assets and rates is an interesting one. Maybe it is just money getting put to work. Maybe it is just positioning because I mean looking for higher rates, steeper curve and lower asset prices, generally, if that's how everybody went into the year and everybody was wrong, well then you got to kind of catch up there and buy all those assets that you were short. So maybe it's a little bit of that and maybe once this positioning move is over and we're only what? Two weeks into the year, so geez, maybe it doesn't take all that long, then things start to turn the other way and we do get those higher yields, steeper curves and maybe more challenged markets. What are your thoughts there? I'm curious.

Sam Buckley:
Yeah, I mean I think it goes back to the markets expecting the Fed to cut rates, which will support the support asset prices more. I mean think-

Ben Reitzes:
Is that hard enough though? Is it enough? That's all.

Sam Buckley:
Yeah, probably not. No, not given the severity of cuts we're pricing in, with where asset prices are. I think that there's a mismatch there because I mean the Fed's, and the Bank of Canada, isn't going to cut that aggressively that quickly unless the economy's in really bad shape and if the economy's in really bad shape then I mean the asset prices we're seeing probably aren't reflective of that, definitely are not reflective of that. So one of them is probably wrong. Not sure which one yet and I think that's what makes this job so interesting and I don't think anyone knows, and maybe they're both wrong. So I think it'll be an exciting year and I think there's a lot to figure out. I mean I think that there's a lot to figure out over the next, call it, month, let alone the next year.

Ben Reitzes:
Yeah, I totally agree. This year's an interesting year. Kind of transition year for policy, for rates. And I still, my bigger picture thoughts on the next 10 years being more challenging on the inflation front is in higher inflation driven by a lot of global factors just hasn't changed.

Sam Buckley:
I was just going to chime in on the general geopolitical uncertainty around that. I mean countries bringing onshore production, things like that, and just more general conflict, whether it's outright or silent, I think that it's going to be interesting. It's going to be interesting.

Ben Reitzes:
It makes for a more challenging backdrop for sure. And for inflation, globalization, economies things just aren't as friendly as they have been for the past 20 years or so. Even if this year inflation pulls back somewhat, I still think that on a secular basis, inflation still will not be as soft as it has been for the past 10, 20 years. There's just a different dynamic ahead. And something just on the side to keep in mind is, I mean China's reopening and right now they're still dealing with a lot of COVID and a lot of people sick and a lot of people not at work and a lot of people not doing stuff. But that will fade over the coming months or so, I mean we've seen this movie before, pretty much everywhere. And that probably means more intensified demand for commodities generally and energy specifically and maybe oil prices go back up to 100 bucks. I know I've told this story before, but I will say it again, it would not be good for inflation and would put central banks in a very tough spot.

You get oil back to 100, 110, 120 inflation goes back up to 5, 6% on the headline after going down to 3 or 4, something like that by the middle of the year. Central banks in a tough spot, the rate cuts that are priced well, poof, they're gone, probably. So that's a scenario at least to keep in mind even if that's not the way things are playing out at the moment.

Sam, I'd be remiss if I didn't ask you what your favorite trades are at the moment. 1030s has been very topical, Canada, the US, consistently so I still think it is a trade, you just got to get it right levels kind of like zero ish to flatten Canada, negative, probably 25 to steepen Canada though that would be my trading range and we're closer to zero now. So maybe an opportunity soon. What else do you see out there?

Sam Buckley:
I like that. I mean I think the 10s bonds box is very correlated to Canada, US levels that we've seen and we've seen a really big richening of Canada US over the past two weeks and that's a cheapening of the 10s bonds box or steepening of the 10s bonds box in Canada, which kind of got into 4-ish yesterday I would say. Yeah, I like that trade. I mean I think watching that range is a good trade. I think being short Canada versus US, if we rally back, I mean we cheat and call it 5 basis points today, if we rally back another 15, 20 basis points, I think you're going to get a few accounts put large structural trades on that haven't already done. So kind of put that as an opportunity, just kind of a lack of divergence trade. Canada's not really going to differ that much from the US in terms of policy. I think that'll be a topical trade.

I think there's generally higher yields. I mean despite the huge rally we've seen in this last two and a half weeks, I do think that we will see higher yields over the next 11 months, definitely at some point, but probably sooner than later. I do think this was a perfect storm rally, really just driven by positioning, new money and a little bit of weaker data and the market's trying to change the narrative a little bit. And I mean, can we go another two weeks? Absolutely. But at some point I do think that higher yields is probably the trade for the medium term this year, short to medium term this year. And does that mean flatter 10s bonds curve? I don't know. I mean we're, call it, 12-ish basis points right now. Can we test zero? Yeah, we'll probably test zero again. I don't think this story is done yet in terms of higher yields, central banks, yeah, I think we probably test zero again. Kind of with the ranges on 10 bonds, we've been seeing higher highs and lower lows over the past two months, shallower lows I guess. So I don't disagree with that. I mean we probably don't hit minus four again, we probably hit zero. Maybe one last final push, a little bit negative.
But I think that, yeah, we'll probably get a little bit of a flattening back in once some of the supplies out of the way and central banks kind of push back on some of the pricing that's gone on through. It really only takes one real data point. I mean to kind of change the market, one serious data point-

Ben Reitzes:
Just a big surprise.

Sam Buckley:
Yeah, big surprise.

Ben Reitzes:
Big surprise would do it. You mentioned lack of divergence or I guess less divergence than expected, I think that might be an interesting theme this year. If the bank gets to four and a half fed may not even get to 5% or maybe the 5% will be the top instead of being the bottom of their range at the end of the day here, they may not breach that level. Because the data we've seen suggests they may not get there at the end of the day, even if the risks on both sides of the border are for higher rates. For now, it looks as though the Fed's going to stop maybe just a little bit shorter. Well, we'll see what the job numbers do in the next few inflation prints. But a down shifting to 25 basis points from the Fed looks likely and if the economy continues to slow the way we've seen, they may be done sooner rather than later. And that means the Bank at 4.50, the Fed at 4.75 to 5, which is kind of low, 480 s and that that's only like a 30 basis points spread, 33 years.

Sam Buckley:
We were there last week.

Ben Reitzes:
Exactly, which isn't huge.

Sam Buckley:
We were there last week. So I think, I mean there's been a bunch of combination of Canada centric factors that have let us outperform, which over time probably pushes us back. But I mean for now it's all about the Bank next week.

Ben Reitzes:
Yup. And we will see what they have to say. Will be interesting and the minutes at least add a new wrinkle there. So we'll see. And Sam, thanks for coming on the show and welcome to 2023 and I hope everybody has a prosperous year.

Sam Buckley:
Absolutely. Thanks for having me.

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:
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