After two consecutive interest-rate hikes, participants in the markets for overnight index swaps and bankers’ acceptance contracts are betting policy makers are set to tighten for a third time this year. Pacific Investment
Management and BlackRock disagree. Both say central bank Governor Stephen Poloz is on hold until at least 2018 and anticipate a more gradual approach to monetary policy.
Swaps traders are pricing in about a two in three chance of at least one more quarter-point rate increase by the BOC’s December meeting. While those odds have slid in recent weeks amid words of caution from Poloz that there is no predetermined path for policy tightening, they still stand about 10 percentage points above the market-implied probability ahead of last month’s hike.
Pimco and BlackRock say uncertainty surrounding NAFTA negotiations, an anticipated slowdown in growth once fiscal stimulus wanes, and muted inflation make it unlikely the central bank will raise rates again by year-end.
Should they prove correct, the implications extend beyond the front end. Speculators have boosted wagers on Canadian dollar strength to the most in almost five years, just months after amassing record short positions against the currency.
"Markets just went from one end of the spectrum to the other end of the spectrum and now the bank is trying to recalibrate them to a more balanced outlook," said Aubrey Basdeo, head of Canadian fixed income at BlackRock, the world’s largest money manager. The Bank of Canada "seemed in a hurry to try and remove the emergency cuts, and they didn’t articulate that," he said, referencing the 50 basis points worth of reductions in the overnight lending rate in 2015.
Basdeo said policy makers are probably willing to let the economy run hot for the time being to combat the lack of private investment that’s been a defining characteristic of Canada’s recovery. "Without doing anything with monetary policy, you can allow the supply side of the economy to catch up with the demand side, while inflation is still quiescent," he said. "If inflation were an issue, then clearly the bank would be moving."
While Canadian growth has outpaced that of its southern neighbour, coming in above 3% year-over-year since March, inflation remains muted. Consumer price inflation dropped below two percent year-over-year in the first quarter, and has stayed there since.
"We don’t really yet see the economy becoming more broadened and self-sustaining in terms of business investment and exports," said Ed Devlin, head of Canadian portfolio management at Pimco. "The combination of a strong currency and the Nafta renegotiations will hurt that."
Short Loonie
The loonie has climbed 7.6% versus the dollar this year. The country sends more than 70% of its exports to the US.
Growth will probably slow to closer to 2% in the next 12 months, Devlin said, and in a scenario in which the Federal Reserve raises rates two to three more times next year, he expects the Bank of Canada might do so once or twice.
Devlin said he’s underweight the front-end of the US bond curve because it’s under-pricing the pace of Fed policy tightening to come, whereas he’s overweight the front-end of the Canadian curve and has a "small" short Canadian dollar position relative to the greenback.
The BOC’s next interest-rate decision is 25 October, during which the Monetary Policy Report containing economic projections is also expected to be released, and Poloz will follow with a press conference. Of the 16 economists surveyed thus far by Bloomberg, a dozen expect the bank to keep the overnight lending rate unchanged at 1%, while four see another 25 basis points increase.
Canada’s September jobs report, due Friday, is likely to influence rate-hike expectations. Economists surveyed by Bloomberg are expecting a gain of 12,000 jobs, slightly more than half of what was seen in August.
“The bottom line is that there’s such a wide range of outcomes right now,” said David Rosenberg, chief economist and strategist at Gluskin Sheff & Associates. “Whatever base-case forecast you have for the Canadian economy, the probability curve is a lot wider than usual. That’s really what Stephen Poloz discussed: there’s a lot of uncertainty and no shortage of downside risks."
MBN
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