Who is Buying Government Bonds at These Microscopic Yield Levels?
March 2, 2015Happy March Break
March 16, 2015
The Bank of Canada (BoC) left its overnight rate unchanged last week, surprising some who expected that it would be lowered again after January’s emergency cut. Instead, the Bank judged the existing degree of monetary-policy stimulus as being “still appropriate” under the current circumstances.
While most observers expected the BoC to stand pat, there was still some uncertainty around what it would do, and I think that was by design. The BoC decided to drop its forward guidance last year, preferring to restore a bit more of an air of mystery to its decision-making process. This approach keeps the market guessing and prevents speculators from getting too complacent or aggressive when betting on the future of Canadian interest rates and exchange rates. For example, when the BoC dropped its overnight rate in January, investors didn’t see it coming and the rate cut pushed both the Loonie and our bond yields quickly and decisively lower, creating maximum impact.
This time the market was ready for a BoC rate cut. And this time, we didn’t get it.
The idea that the BoC would cut rates last week was primarily based on historical precedent. When the Bank has dropped its overnight rate in the past, it has typically done so with a series of cuts before pausing to see how our economy absorbs the stimulus. But today we live in anything-but-typical times and the BoC’s decision to stand pat is in part a reminder that the monetary-policy road maps from past garden-variety recessions offer us little insight into what might lie ahead.
Here is a summary of the factors that led to the BoC’s decision:
- The Loonie sold off again after the BoC’s January rate cut, giving our exports an additional competitive boost. The power of the cheaper Loonie is finally evident in our economic data, which showed that the export-oriented part of our economy grew twice as fast as our overall economy in the fourth quarter of 2014. Last week David Rosenberg estimated that the 4% drop in the Loonie that accompanied the BoC’s surprise January rate cut gave our economy a stimulus that was equivalent to a whopping 4.00% drop in rates. Thus, the steep drop in the Loonie bought the BoC some time to let events unfold before deciding on its next move.
- In his accompanying commentary, BoC Governor Poloz explained that the Bank moved decisively with a rate cut in January because it expected that the negative impacts of sharply lower oil prices, such as job layoffs and reduced business investment in the oil patch, would be front loaded. At the same time, the Bank believed that the economic benefits of lower oil prices, such as cheaper gas prices and the increased competitiveness of our exports, would take longer to accrue. In that context, taking a wait-and-see attitude, after giving our economy some initial cushion with the January rate cut, makes sense.
- The BoC is now less concerned about the risks of disinflation and outright deflation. In January the Bank said that it was worried that sharply lower oil prices “increase[d] both downside risks to the inflation profile and financial stability risks”, whereas last week the Bank said that “the risks around the inflation profile are now more balanced and financial stability risks are evolving as expected”. This reduces the immediate urgency for more monetary-policy action.
- Despite its protestations to the contrary, the BoC can’t discount the importance of the U.S. Federal Reserve’s next rate move when charting a path for Canadian monetary policy. While Fed Chair Yellen still sounds cautious on the timing of the Fed’s next policy-rate increase, most experts believe that the Fed will being to tighten its monetary policy sometime in 2015. If the BoC cuts its overnight rate again, at or around the same time that the Fed tightens its equivalent policy rate, this could cause a sharp and destabilizing swing in the U.S./Canadian exchange rate. Thus, the BoC would prefer to preserve its flexibility as it waits for the Fed’s next move.
The only part of the BoC’s recent commentary that puzzles me is Governor Poloz’s continued insistence that the Bank is not trying to push the Loonie lower. He has repeatedly said that any sustainable Canadian economic recovery will require a rebound in export demand that will fuel increased business investment. A cheaper Loonie offers the easiest and most comprehensive way to buoy our exports, and if the Bank isn’t overtly trying to make this happen, its actions could hardly be better designed to achieve this end.
When you look at the unprecedented and extreme approaches being adopted by so many of the world’s largest central banks, what’s the harm in talking down your currency to give your exporters a boost? Especially for a small, open-market economy such as ours? Doing so provides weakened and vulnerable parts of economy with much-needed stimulus without any of the radical balance-sheet expansion we have seen in other countries, and this dovetails perfectly with BoC Governor Poloz’s key goals for our economy.
BoC Governor Poloz can continue to deny that the Bank is adopting policies that are designed to push the Loonie lower, but the evidence to the contrary is overwhelming. If it walks like a duck, has feathers, a yellow beak, and quacks, Governor Poloz can call it what he wants but for me, it’s a duck.
Five-year GoC bond yields surged by twenty-seven basis points last week, closing at 1.00% on Friday. Five-year fixed-rate mortgages are still offered in the 2.59% to 2.69% range, and five-year fixed-rate pre-approvals are available at rates as low as 2.74%.
Five-year variable-rate mortgages are available in the prime minus 0.65% to prime minus 0.80% range, depending on the terms and conditions that are important to you.
The Bottom Line: The BoC has restored an air of mystery to the decision-making process of its monetary-policy that enhances its ability to impact bond yields and exchange rates and to keep would-be speculators on their toes. For now, the Bank is adopting a wait-and-see approach and while that means that our mortgage rates won’t be headed lower in our immediate future, nor should they be moving higher any time soon.