The Bank Of Canada Will Have To Face The Music As Summer Comes To A Close
Unlike its American counterpart, the Bank of Canada officials rarely give any clues to their intentions between policy meetings. This summer the Governor has essentially been observing radio silence. Meanwhile, the financial markets have been in turmoil, to say the least. In particular developments in the collapse in bond yields have caught the attention of policymakers worldwide. Calls for additional rate relief have come from varying quarters in the US. The majority of Fed watchers now anticipate another rate cut in September. The Fed is feeling the pressure to get ahead of the curve and prevent a recession with a series of rate cuts over the balance of the year.
Meanwhile, in Canada, the situation is quite different, or so it seems. At its last rate-setting meeting on July 10th, the Bank of Canada let the bank rate remain at 1.75%, as the Governing Council felt that the Canadian economy would pick up later in the year. Overall, the Bank believed that the economy was operating near or at its potential and inflation remained within its target range of 2%. They believed that monetary policy was appropriate for the current and near term conditions.
With no scheduled meeting until Sept 5th, the Bank officials will no doubt will have a full agenda, dominated in large measure, by the developments in financial markets since their July meeting. The Governor has gone on record as saying, in effect, the recent yield curve inversion in Canada did not necessarily indicate a serious slowdown was in the making. He preferred to characterize the bond market as experiencing an “innocent inversion”, an interesting turn of phase. However, the drop in long- term yields is anything but innocent. Following closely the developments in the US Treasury market, the Canadian 30yr bond fell below the rate recorded in 2016 and now yields 1.31%. What is most revealing is that the 30yr rate is 25bps below the 3-month rate. The short end is very much influenced by Bank policy. The Bank has given no indication that is prepared to cut rates, yet the bond market is signaling trouble lies ahead.
(Click on image to enlarge)
Figure 1 Comparison of the Canadian Yield Curve August 15/18 with August 15/19
It was only a year ago that the Canadian yield curve exhibited a positive slope, indicative of a growing economy with the prospects of higher rates in response to improved economic activity. Today, the curve exhibits the total opposite conditions. While the Bank stubbornly maintains short term rates at relatively high levels, investors have been pushing yields down in the medium ( 5yr) and long term(10yr) ranges. They do not share the Bank’s optimistic outlook for Canada. The events of this summer have overtaken Bank policy. No longer can the Bank maintain that the outlook for Canada warrants no change in monetary policy.