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WWJD - Views from the North

FICC Podcasts Nos Balados 15 septembre 2022
FICC Podcasts Nos Balados 15 septembre 2022

 

Disponible en anglais seulement

In this episode, Joel Prussky, BMO’s OIS and cross-currency trader, joins me to discuss last week’s Bank of Canada 75 bp rate hike, whether he’s still bearish on duration, the outlook for CAN/US yield spreads, and his favourite trade ideas.

As always, all feedback is 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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Ben Reitzes:

Welcome to Views from the North, a Canadian rates and macro podcast. This week I'm joined by Joel Prussky, BMO's OIS and cross-currency trader. This week's episode is titled WWJD: What Would Joel Do?

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.

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@B-M-O.com. Your input is valued and greatly appreciated.

Ben Reitzes:

Last week Joel, Bank of Canada hiked rates 75 Basis Points as expected. They changed their tone a little bit, talking more about the end point for rates rather than the pace of rate hikes. It suggests they could slow down and maybe they're nearing an end to the aggressive hikes that they've put in place. What are your thoughts on that at this point?

Joel Prussky:

Well, I would tend to agree. I think it's clear to me that the tone did shift a little bit and the bank is getting ready to prep the market with the idea that we have done an incredible amount of hiking in a very short period of time on some forward looking indicators. Things look like they are slowing down considerably, and that it would be prudent to, at some point, have a pause to reflect on how far we've come? I think that they went through the first steps of getting ready for that.

Joel Prussky:

The next step is probably the October meeting where they let the market know that they're reaching a point, and I don't want to call it terminal, but I'll call it terminal for 2022, where they'll say, "Let's marinate a bit with what we've done and let's see where we are, and let's see what brings over the next few months?"

Ben Reitzes:

Okay, so temporary terminal or at least where they pause 375 or 4%.

Joel Prussky:

Pick one of those. Sure, one of those.

Ben Reitzes:

Okay, either way, and what about '23? Any thoughts on 2023? Will they keep going? Are you just going to see what the data says? Because I mean for me, that's all that really matters and given the volatility in the market and the data generally and the general uncertainty, it's a pretty tough call to make at this point. But the risks point to more rather than less.

Joel Prussky:

Well, I'd like to say a few things on this topic, Ben, if you would indulge me.

Ben Reitzes:

I will happily indulge you.

Joel Prussky:

One is going to be, it depends when they finish. If they finish in October, then by March of 2023, they could be back in the game one way or another. If they finish in December, it's probably a little bit later, so that's the first thing I'd say.

Joel Prussky:

Here we are talking about what's going to happen in the March meeting when we're not even a week barely out of the last meeting. I mean, this is the joke of the market. I mean, let's get our head screwed on straight. We just had a hike. We just spoke about stuff about the hike and we're already worried about when the cuts are coming in 2023?

Joel Prussky:

What I will say about 2023 is this is a central bank, along with the rest of the central banks in the world, who have yet to ever see a crisis coming. They're crystal ball's as cloudy, if not cloudier, than all of ours, as is mine. I don't know what's going to be in 2023. I don't think that we're going to get the kind of move back to 2% inflation that the central banks, at least in North America are hoping, which bodes for high for longer.

Joel Prussky:

That may mean a higher terminal and it may mean we get to 5%. I know it's unfathomable to most people under the age of 40 in the market, but it's quite possible that the hiking campaign starts again if inflation doesn't start to behave. Or, that we sit at 4% for a very long time, a long time being a year or two.

Joel Prussky:

If that's the case, I think then the market has some explaining to do in the sense of the inversion, which really has come off a little bit. But still, we're pricing in somewhat significant rate cuts for 2023 already.

Ben Reitzes:

You talked about a pause earlier and then the potential for cuts. I guess my only counter argument to them continuing in 2023 with rate hikes would be the reason they're pausing in the first place. This is more of a Canada argument than a US argument.

Ben Reitzes:

We're a very indebted society. Housing is already under huge pressure and wait three months and it's going to look that much worse because we really haven't felt much impact of rate hikes yet, quite frankly. Debt payments are going to go up substantially.

Ben Reitzes:

Just, I'm trying to work through the numbers right now, but if you go back to the last time we had overnight rates with a four handle, the effective average interest rate for Canadians was north of 6%, about 6 1/2%. Now we're looking at about 3.6%, so you're looking at a three percentage point increase in borrowing costs. That would cost about $80 billion a year, or 5% of disposable income. If you chop off 5% of disposable income, we're in deep trouble.

Joel Prussky:

Well, on top of the rampant inflation everywhere else that's sucking the excess money, the excess savings out of the economy.

Ben Reitzes:

Yeah. You have this huge increase in rates that really hasn't fully flowed through yet. Inflation is a great point because it means everything costs more and then you have that much less. Your real disposable income is that much less, and so the economy's going to suffer potentially very badly next year.

Ben Reitzes:

Even if inflation is still sticky at that time, if the economy is headed for a potentially, I don't know how deep, but a recession, how willing is the bank going to be to continue to raise rates in that kind of environment?

Joel Prussky:

The truth is, the current generation of central bankers don't even know what that means? You're speaking words they don't understand. Right now, I mean it's really a political game. Which way is the wind blowing? Right now, the wind blowing is we must create and stop inflation at all costs in the middle of a housing 20% crash and a deep recession where job cuts are happening. Then all of a sudden maybe that changes.

Joel Prussky:

I mean, I think given the current government in place in Canada, the hybrid NDP Liberal government we have, there'll be a lot of crying uncle the minute job losses start happening. But that's not today's trade. Look, I think when we speak in the US, Powell seems very clear that he is willing to tolerate a severe downturn. I don't know that the same will hold true in Canada. It may or may not. I don't know. Like I said, I don't think anyone knows what's going to be six months from now.

Ben Reitzes:

No, that's fair.

Joel Prussky:

I'm not trying to pontificate about that stuff, I think. I just know more near term and near term the job is almost done, I think. The Bank of Canada's current job is almost done.

Ben Reitzes:

Okay. I guess my only, my biggest point would be that Canada is that much more sensitive to rates.

Joel Prussky:

All the more reason.

Ben Reitzes:

More than the US, and so the bank probably when they get to their pause, it would surprise me if we don't get a meaningful slowdown in growth. How slow, I guess depends. That will determine whether they have to keep raising rates or not.

Ben Reitzes:

In the US there's a much better chance they have to keep going and that economy is that much more resilient, and the latest job numbers should really exemplify that. You get plus 300,000 in the US, which comes on the back of a plus 500,000 print before that for jobs.

Ben Reitzes:

Whereas, in Canada you have three consecutive negatives. We'll see what next month brings? I suspect it will be positive, just because the education quirk in there. But it's still that the backdrop in Canada is much less friendly, I think, than in the US. The Bank of Canada has a somewhat more challenging policy backdrop. Well, I guess we'll see.

Joel Prussky:

But I still think that's a 2023 story for the Fed as well because the Fed can't keep hiking all the time and say, "Well, wait a minute, inflation isn't coming down." I mean, OER is a massive lagging indicator and we're freaking out about an inflation number that didn't satisfy the market's desire a day or two ago when a huge component of that was OER, which we know in six to 12 months is going to start turning down. But the market is, I get why they're very fixated.

Joel Prussky:

My point is I think, I don't disagree with you on the US but I still think it's a 2023 story and I still think at some point, the US has to say in a similar vein, "We've done a lot of hiking. We're QT-ing a lot, let's see the effect of this."

Ben Reitzes:

Enough.

Joel Prussky:

"And by all means we're not done, and we're not saying job done," Powell will say, "And if we have to hike more we will." But you can't just hike 75 at every meeting until you finally see CPI tick down the two tenths you want it to.

Ben Reitzes:

I totally agree. Which Fed officials said that they want to keep hiking until inflation is clearly trending down and materially lower? That isn't the way you're supposed to run policy. It takes too long for policy to work. That means they could be hiking until 5, 6, 7% if they're waiting for inflation to actually fall.

Ben Reitzes:

The one thing I will challenge what you just said, it wasn't all OER. OER was probably about, of the core, it's just about two ticks I believe of the six and four if you take out OER is still a lot, so there's still some. I think, for me that was the troubling part of it. It's not a lot of guys missed on OER, a lot of the forecasters, that's fair.

Ben Reitzes:

But it was more than that, and you look at any of the other funny enough Canada type underlying inflation metrics. They have means and weighted medians in the US as well, and they all picked up notably as well. It's not a comforting story for the Fed. Clearly, more rate hikes are coming there and could be 75 next week could be 100. What do you think about that?

Joel Prussky:

Let's not forget one thing. Rates in the US are still 100 Basis Points below where they are in Canada, and we keep talking about this. Oh, more hikes, and then Canada has to price in more hikes and it's a daisy chain of hikes. Rates in Canada are 100 points higher than they are in the US right now.

Joel Prussky:

That will change next week. I think, probably 75 next week. I think, you can't keep hammering that nail forever and expect it to go any more through the wood than it is, so I think 75 with continued talk of more to come.

Ben Reitzes:

All right. Well, we'll see what the market's pricing because if the market gives them-

Joel Prussky:

Market's at 80, I think at the moment.

Ben Reitzes:

If they get above whatever, into the high 80s, that probably changes that ballgame a little bit, and we'll see if the Wall Street Journal likes to drop any stories on Monday. "Oh, by the way, 100 this time." We'll see about that.

Ben Reitzes:

Moving right along, but I mean similar topic, my first episode with you was all about your views on duration, and you were quite bearish and that has proven to be right. Congratulations, sir.

Joel Prussky:

Yeah, thank you.

Ben Reitzes:

That's it? No gloating?

Joel Prussky:

I don't think I'm a genius, to be honest with you. I mean, rates were probably what, under 1% when we first talked. That's not a natural number. It's not the right number. It should never be the right number. Zero is the wrong number for overnight rates, and 1% is not the right number for ten-year money, so I honestly don't think I'm a genius. I just think that I tried to have a slightly bigger picture view.

Ben Reitzes:

I still expected more gloating.

Joel Prussky:

Way to go, Joel.

Ben Reitzes:

From here, with US tens, we're 340-ish today, give or take.

Joel Prussky:

Sure. Let's round it to 350 just for fun.

Ben Reitzes:

Well, my point is we're not at 350 and we haven't broken through that level.

Joel Prussky:

Right.

Ben Reitzes:

Do you still think we go higher? Are we going to breach 350 in tens and continue to push? Are we going to see a four handle in tens and longs in US and Canada, for that matter?

Joel Prussky:

What's your time? What's our time? What are we talking here, the next three weeks, six weeks?

Ben Reitzes:

No, it's a year. Why don't we say over the next six to 12 months?

Joel Prussky:

I think the range in tens over the next six to 12 months is probably two and two and three quarters to four and a quarter. I think we're in the middle of the range. I think there's still way too many market participants who think that the last 15 years is what's "normal" and I'm not sure that's the case.

Joel Prussky:

If structural inflation is here to stay and inflation at the best really runs more like three and a half, four, then I think it's quite possible that tens trade four or higher, or stay high for a long time, and we don't get these massive rallies. I don't think we'll ever relive the Zero Lower Bound in my trading lifetime, granted.

Ben Reitzes:

That may not be long.

Joel Prussky:

Granted, I've been around a long time and I might not be around for a long time, but I think they know now that's not the best way to really stimulate the economy. I mean, we've proven fiscal is a way better way to get money in people's hands and zero rates just cause a whole bunch of excesses all over the place. I think if that's the case, I think 2% is a floor for tens going forward, and if I had to really make a wager, I would think we're much more likely to see 5% than 1%.

Ben Reitzes:

Oh, on that I agree, definitely. The structural argument is one that I like a lot. Just the geopolitical side of things, I think we've gone from a unipolar world where the US just dominates and trade flows are dictated by them, and everything is free to move around the world without any real friction, to a multipolar world where nobody really gets along.

Ben Reitzes:

China's got their own wants and needs, and Russia's got their own wants and needs, and the West has their own. And that means that we all fight over the same size pool of resources, but there are way more redundancies than you would've had in the past.

Joel Prussky:

Absolutely.

Ben Reitzes:

Everybody wants their own chip factory in their country and their own whatever factory in their own country.

Joel Prussky:

The US has weaponized finance as well, so if I was Chinese, I would never buy a Treasury note again knowing that they could be used in a time of conflict against me. The US has some deficit problems, so they have Social Security problems that at some point those all do need to be funded. If you just manage to piss off your largest buyer, I mean to me that's an argument for a much deeper curve and a much higher long end rates at some point.

Joel Prussky:

I mean, look what happened in the UK in the space of three weeks. I mean, the bond market just collapsed because they realized, wait a minute, who's going to buy our paper? Yes, the US still has exorbitant privilege at the moment, but empires all fall. If you look at how they're tearing themselves apart, as you said, multipolar world is coming.

Ben Reitzes:

Yeah. I don't know if the US downfall is coming with that.

Joel Prussky:

But multipolar by definition means their prominence is going to be diminished relative to what it was.

Ben Reitzes:

To some extent, yes.

Joel Prussky:

That has a cost, I think.

Ben Reitzes:

Something that I heard on, I can't remember which podcast very recently. Over the past, it's really 30 years or so, you've had periods where big global buyers of Treasuries. Japan, big global buyer, then China, big global buyer for a decade. Then the Fed became the big global buyer for a decade and now who's the buyer? I don't think China's buying more. I don't think Japan's buying more, and I know the Fed's not buying more. In fact, they're going the other way.

Joel Prussky:

That was the Odd Lots Podcast.

Ben Reitzes:

There you go.

Joel Prussky:

Poszar, and yeah.

Ben Reitzes:

Yeah, and so who is the buyer? I don't have an answer for you. I mean, I think that's a good-

Joel Prussky:

But that's the supply and demand thing and maybe at 5% there's interest.

Ben Reitzes:

Well, that's it.

Joel Prussky:

People will be interested. Domestic buyers will be interested in buying it at 2 1/2%, with inflation running at four, I don't know that that's the case. Regulation has forced so many banks in the US to buy HQLA assets and there's nothing Q or L about them we found out. It turns out that they're not Q and they're definitely not L because all I hear about is how bad the liquidity is in the Treasury market.

Ben Reitzes:

It's all relative. It's better than everywhere else though probably. Yeah.

Joel Prussky:

Perhaps.

Ben Reitzes:

Given that you think Treasuries are more likely to get to 5% than 1%, 10 Year Treasuries, where is Canada going to go in that scenario? Does Canada follow suit? Do we outperform? Do we underperform? Where does Canada show up on the radar? It's important to note that Canada has performed very well of late. We were trading back Treasuries in 10s, 20, 25 Basis Points a month ago.

Joel Prussky:

25 Basis Points.

Ben Reitzes:

A month and a half ago, and now we're 25 Basis Points through. Two years went from 40 Basis Points back and now we're trading about in line, so Canada's had a really, really strong run of late. Is that going to continue or is this just kind of flash in the pan?

Joel Prussky:

Well, I mean think, look, we all wear different hats at different at times here. This is a macro-ish podcast, so we're talking about what's happening in the next week sometimes, sometimes in the next three months. I think near term, if you've been in Canada, US, you've had a great run. I would take it off here. I would even entertain going the other way, especially in fives because mostly because I think Canadian fives are heinously rich, but that's a story for another day probably.

Joel Prussky:

But definitely, if you've been in it and tens have moved 50 Basis Points, the casino's always open, I like to say. There's always a chance to get back in. In a textbook bear market where tens actually got to 4 1/2%, sure. Canada would, I believe, outperform. There's no doubt about it. But I think in between now and then a lot of things can happen.

Joel Prussky:

I mean, if the Canadian dollar's at 140, that exacerbates our inflation problem and that may change the Bank of Canada's reaction function. I can't really say for sure about that. I think from a near term trading perspective, I would not be long Canada, short US at this juncture right now. I think it's been a great run. I think if you've been in it, it's time to get out. I even think that there are times for a trade, for a short term trade, to look to go the other way.

Joel Prussky:

I do think, structurally, I believe you should be buying Canada on dips versus the US when it cheapens up. But at 25 through and tens, I don't think we're cheap and terminal's now 25 through as well, which is again, not cheap. Terminal when we were 25 above was cheap. So again, the 50 bps is a kind of universal across the curve, so I think it's probably a good time to exit stage right.

Ben Reitzes:

That makes good sense. I think the move in the front end, the terminal, I didn't realize they didn't move that far, so that's good to know. Generally, I agree. I don't know if I'd be getting short Canada, but that would be super tactical and you better be in touch with the flow on that because-

Joel Prussky:

Well again, that's the macro version of the market maker, right? I mean, again, two hats, right? There's times when we get put into risk and the best hedge for that risk may be along US position for a short term for a trade.

Ben Reitzes:

Fair enough. You said the five year point in Canada is heinously rich. Instead of another time, why don't you give us a 30 second synopsis as to why it is heinously rich?

Joel Prussky:

Well, I think it's heinously rich at the moment because I think bank balance sheets are starved to mortgages. Which means they have to go out and they have to receive fixed, and they pick the five year sector to do it because that's what it says when you open up asset liability management for dummies.

Joel Prussky:

Not that they're dummies, I'm not calling any of you dummies, but that's on page one and you receive fives, and twos, fives, tens is almost at minus 55 in Canada, which it historically is very inverted. Fives, tens, thirties is actually quite positive, so if you're looking at the two, twos, fives, tens, verses fives, tens, thirties, we're up near almost all-time highs, so that's why.

Joel Prussky:

I also think that fives are built on the house of cards that is imminent rate cuts or near term 2023 rate cuts. When you start realizing that the central banks of the world aren't bringing those in, I think that that twos fives curve is simply too inverted.

Ben Reitzes:

In defense of those receiving the five year, the five year sector is where the fixed mortgage does print and when home sales collapse.

Joel Prussky:

Absolutely.

Ben Reitzes:

I'm just saying that's why it's the first page is all I'm saying.

Joel Prussky:

They're going to be receiving 360.

Ben Reitzes:

Yes.

Joel Prussky:

And they're going to be paying 4% for the next year. If the bank goes to 4%, CR goes to 435.

Ben Reitzes:

Yeah, I didn't say it was a good trade.

Joel Prussky:

They're going to have negative 75 bps of carry for the next year or possibly two. I guess my point is, I do understand that they're pre-programmed to receive five years, but at some point the curve should say to them, "Wait a minute, we want to be, maybe we'll look at three years or something else."

Ben Reitzes:

Yep.

Joel Prussky:

There are many other points on the curve other than five years.

Ben Reitzes:

The negative carry there is not going to be friendly for sure.

Joel Prussky:

No, no.

Ben Reitzes:

Why don't we leave it there. Joel, why don't give us your favorite trade idea at the moment.

Joel Prussky:

Sure. Let's talk, I mean two trade ideas that I like. I think one is, we've got the December meeting here right up against 4% and I think even January is at 405 or so, 406. I do think that that's going to be terminal for 2022. It may even occur at the next meeting.

Joel Prussky:

It's quite possible we get 75 and done from the bank, so I wouldn't mind taking a stab at the receive side at 4%. I think you can do some of it outright. I think you can do some of it against the October meeting in the event that the bank does the 75 and done type of thing.

Joel Prussky:

I also think you can do some of that not only outright but versus the five year point, which I think is very rich. I would target that. Receive decent Jan, pay October and pay five year.

Ben Reitzes:

Okay.

Joel Prussky:

The other trade I would do, which is in the cross-currency space, is the four-year, one-year, five-year, one-year steepening in cross-currency. So for core, you could do it in core SOFR as well. There has been a fair amount of receiving of the ten-year point from reserve generation from the Central Bank that's given dealers ten-year risk they don't want and can't move.

Joel Prussky:

It's had an effect of inverting the curve, the basis curve, quite heavily. We have a very steep out to five-year point and then a very flat to inverted out to ten-year point. For whatever reason, this street seems unable to understand what six-years are worth. So, the four-year, one-year, five-year, one-year cross-currency swap is close to minus seven-ish. That rolls down to plus two in a year.

Joel Prussky:

In my history of trading cross-currency swaps, which arguably hasn't been that long, only 30 years or 28 years, this is the dumbest thing and the most low hanging fruit I've ever seen. I think if you are going to trade cross-currency RV, then this trade has to be done and it has to be done in as much size as you can get done.

Ben Reitzes:

Okay. If that's not convincing, I don't know what is. I don't have anything better to give our audience, so why don't we leave it there for today. Joel, thanks as always for coming on.

Joel Prussky:

Benny, always 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.

Announcer:

The views expressed here are those of the participants and not those of BMO Capital Markets, its affiliates or subsidiaries. For full legal disclosure, visit bmocm.com/macrohorizons/legal.

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

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