U.S Fed Chair Yellen Buys More Time and Bank of Canada Governor Poloz Makes Me Do a Double Take

In today’s post we’ll focus on comments made last week by both Bank of Canada (BoC) Governor Poloz and U.S. Fed Chair Janet Yellen.

The U.S. Federal Reserve’s Latest Guidance

The U.S. Fed offered its latest market guidance last week using both its post-meeting formal statement and accompanying press conference comments from Fed Chair Janet Yellen.

The Fed finds itself in an increasingly difficult position when issuing policy statements, as I detailed last week. In essence, its delicate choice of words must prevent any rise in irrational exuberance while at the same time not triggering a spike in bond yields by disrupting markets with overly hawkish language around the timing of its future interest-rate hikes, as it has done previously.

Here are the highlights from the Fed’s latest communications:

• The Fed decided to avoid risking a short-term spike in U.S. bond yields by retaining two key phrases that it has repeatedly used to reassure investors that rates aren’t headed higher anytime soon. It said that it would “maintain the current target range for the federal funds rate for a considerable time” and that the U.S. economy was still experiencing a “significant underutilization of labor resources”. Many market watchers speculated that the “considerable time” phrase would be removed, but it wasn’t.
• The Fed knew that investors were anticipating some change in its policy guidance in response to a broad range of improving economic data. It decided to exercise caution on that front, but still wanted to temper a “low-rates-forever” mindset that might fuel an additional surge in speculative investment. To that end, in her accompanying comments, Fed Chair Yellen cautioned that the key phrase “considerable time” could be shorter than many people expect. The Fed also raised projections for the Fed funds rate in both 2015 (1.375%) and 2016 (2.875%), meaning that its key policy rate is now forecast to increase along a steeper path (peaking at 3.75% by the end of 2016).
• The Fed lowered its growth projections for U.S. GDP in 2014 and 2015, which correlates with falling inflation, while at the same time acknowledging that employment conditions had tightened further over the past several months, which correlates with rising inflation.

After doling out a little fodder for both the interest-rate hawks and the doves, so as to ensure that neither camp would be nervous enough to trigger significant market volatility, Fed Chair Yellen emphasized that the Fed’s future path would be data dependent. This phrasing gives the Fed the flexibility it needs to react to significant market changes when they occur, but as a consequence, it also leaves the market free to interpret how each new economic data point, good or bad, will affect the delicate balance of forces that are keeping the Fed in a neutral position.

In the end, I think the Fed wanted to stall for time so it could continue to let the recovery evolve under a lighter Fed hand, which it succeeded in doing. This is much harder than it looks when you’re the world’s most important central bank and the market parses your every word.

How BoC Governor Poloz Made Me Do a Double-Take

Last week BoC Governor Stephen Poloz said that the Bank would not try to influence the value of the Loonie through either its actions and/or its words, and would instead focus on its primary objective of maintaining price stability by using monetary policy to control inflation.

My initial reaction was … really? Did he keep a straight face when he said that?

Governor Poloz has made it clear for some time that a sustainable Canadian economic recovery requires export-led growth which will eventually stimulate increased investment spending by businesses. Exporters benefit from a cheaper currency, and at every pivotal moment since taking over as Governor, Mr. Poloz’s comments have seemed designed to push the Loonie down. If this was not his explicit intent, then we have the mother of all coincidences on our hands.

To cite some recent examples:

• Shortly before last month’s inflation data were released, Governor Poloz helped pre-empt a spike in bond yields and the Loonie by predicting that our recent bout of higher inflation would prove temporary. (In the end it did, and a short-term run up in the Loonie, which would have otherwise been expected as a natural market reaction to the data, was avoided.)
• When our employment data showed signs of improvement earlier this year, Governor Poloz soothed the nerves of twitchy bond investors when he said that our labour market still had plenty of unused capacity and that it would be some time before our economy absorbed that additional slack. (Once again, bond yields stayed calm and the Loonie didn’t react.)
• Recently, the U.S. Fed hinted that it might raise U.S. short-term rates more quickly than markets have been expecting. Since that time, BoC Governor Poloz has repeatedly said that the BoC would have no problem lagging the Fed when it embarks on its next tightening cycle, which is made easier by the fact that our policy rate currently sits at 1% whereas the U.S. Fed’s policy rate remains stuck at 0%. A couple of years ago, most investors would have expected the BoC to match the Fed’s rate tightening timetable closely, but Governor Poloz’s statement left little doubt about present circumstances. (Here again, his words seemed identical to those he would have used if his primary objective was to keep the Loonie from rising in sympathy with a sooner-than-expected Fed tightening cycle.)

More believably, Governor Poloz said that the BoC would not surrender its independent control of its monetary policy in order to maintain a given U.S. exchange rate. In the example he used to illustrate how this would apply to present day, Governor Poloz said that the Bank would prefer to let the Loonie fall, if the alternative meant moving short-term rates higher in lock step with the Fed to maintain current exchange rates. (Exporters would celebrate this of course, but once again that is only by … ahem … sheer coincidence.)

I believe him on that last point, but when Governor Poloz says that the BoC does not worry too much about the impact that its comments will have on the Loonie, and that the Bank does not actively use “verbal guidance” as a soft policy tool, I’m just not buying it. If it looks like a duck …

Five-year Government of Canada (GoC) bond yields were flat last week and, after experiencing some significant volatility, closed at 1.71% once again on Friday. Five-year fixed-rate mortgages are available in the 2.79% to 2.89% range, and five-year fixed-rate pre-approvals are now offered at rates as low as 2.94%. Borrowers who are actively looking to purchase or refinance in the near future remain well advised to lock in a pre-approval as soon as possible to mitigate the risk of an imminent increase in fixed mortgage rates.

Five-year variable-rate mortgages are available in the prime minus 0.80% to prime minus 0.65% range, depending on the terms and conditions that are important to you.

The Bottom Line: Last week the U.S. Fed decided to stall for a little more time before formally committing to a more aggressive monetary-tightening path. Even when that tightening eventually takes place, Canadians can take comfort in the BoC’s repeated reassurances that it won’t be bound by the Fed’s more aggressive tightening timetable. And, if that reassurance happens to help keep the Loonie cheap, and if that happens to support the export-led recovery that is the key to Governor Poloz’s view of our brighter future, why that’s just a coincidence.