Canadian interest rate futures

There are three Bank of Canada announcements concerning interest rates for the rest of the year: September 6, October 25 and December 6.

Right now 3-month Banker’s Acceptance rates are 1.2%.

The BAX futures are signalling that there is a better than 50/50 chance that rates will increase 0.25% in the September 6 cycle, and that there is a slight chance of two 0.25% rate increases by the end of the year:

Month Bid price Ask price Settl. price Net change Open int. Vol.
Open interest: 942,178 Volume: 86,058
August 2017 0 0 98.765 0 0 0
September 2017 98.655 98.660 98.645 0.010 137,868 7,160
October 2017 0 0 98.615 0 0 0
December 2017 98.500 98.505 98.490 0.010 224,303 15,544
March 2018 98.395 98.400 98.375 0.020 163,606 19,552
June 2018 98.330 98.335 98.305 0.025 112,558 15,558
September 2018 98.270 98.280 98.250 0.030 120,395 10,055
December 2018 98.210 98.220 98.200 0.020 102,302 9,439
March 2019 98.160 98.170 98.140 0.020 45,030 5,208
June 2019 98.090 98.100 98.080 0.020 17,655 1,763
September 2019 98.010 98.030 98.010 0.010 10,774 827
December 2019 97.940 97.960 97.940 0.010 5,193 646
March 2020 97.860 97.870 97.870 0 2,199 198
June 2020 97.780 97.800 97.800 -0.010 295 108

Guessing the impact of these short-term interest rate changes I will leave as an exercise to the reader for now. The one salient fact, however, is that when short-term financing rates increase, the incentive to leveraging decreases and so marginal investments will be less viable. Parking cash in a rising-rate environment is best done with cash rather than using any debt instruments with duration (I wish I had stuck to this – my cash parked in VSB.TO has decidedly unperformed zero-yield cash!).

Canadian Interest Rate Expectations

Today, the Bank of Canada announced it was keeping the target short-term interest rate steady at 1%. This was not a surprising announcement. The big concern on the minds of the bank is the escalation of household credit. It will blow up eventually (especially whenever interest rates rise again) but in the meantime, conditions continue to be very ripe for future borrowing.

I guess the financial tip of the day is to make sure to start deleveraging before everybody else does!

Month / Strike Bid price Ask price Settl. price Net change Open int. Vol.
Open interest: 651,369 Volume: 128,687
March 2013 98.715 98.720 98.720 0 87,081 3,000
April 2013 0 0 98.705 0 0 0
May 2013 0 0 98.720 0 0 0
June 2013 98.750 98.760 98.760 0 117,907 18,450
September 2013 98.800 98.810 98.800 0.010 140,414 30,685
December 2013 98.810 98.820 98.810 0.010 126,676 26,022
March 2014 98.790 98.800 98.790 0.030 85,272 21,108
June 2014 98.750 98.760 98.750 0.010 53,319 16,547
September 2014 98.690 98.700 98.690 0.030 17,236 8,173
December 2014 98.610 98.620 98.610 0.010 13,242 2,706
March 2015 98.520 98.540 98.530 0 5,555 1,051
June 2015 98.430 98.450 98.440 0.030 1,559 566
September 2015 98.340 98.350 98.350 0 1,723 149
December 2015 98.250 98.280 98.270 0 1,385 230

BAX Futures state that rates are not going to rise again for the remainder of 2013, and there is the expectation of a chance (but not certainty by any means) of a quarter-point hike around March 2015.

Canadian short-term interest rate projections

BAX Futures are as follows:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 12 OC 0.000 0.000 98.820 0.000 0
+ 12 NO 0.000 0.000 98.780 0.000 0
+ 12 DE 98.730 98.735 98.745 -0.015 10452
+ 13 MR 98.710 98.720 98.750 -0.030 27000
+ 13 JN 98.680 98.690 98.730 -0.050 32803
+ 13 SE 98.650 98.660 98.690 -0.040 19232
+ 13 DE 98.610 98.620 98.660 -0.040 11758
+ 14 MR 98.570 98.580 98.610 -0.030 1998
+ 14 JN 98.520 98.540 98.560 -0.020 1257
+ 14 SE 98.470 98.480 98.500 -0.020 613
+ 14 DE 98.410 98.430 98.430 -0.010 525
+ 15 MR 98.340 98.360 98.370 -0.010 123
+ 15 JN 98.280 98.300 98.310 -0.010 50
+ 15 SE 98.210 98.230 98.240 -0.020 50

The market is pricing in the anticipation that rates may increase a quarter point in 2013 but nothing yet substantive.  In particular, the September 2015 projection of a 1.5% target rate is an interesting bet from a risk/reward perspective.  Three-month corporate paper is at 1.16% and has been this for quite some time.

Canadan Short-term interest rate speculation

BAX Futures are pricing in a chance for a quarter-point rate cut by the Bank of Canada:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 12 JN 98.740 98.745 98.740 0.005 17775
+ 12 JL 0.000 0.000 98.735 0.000 0
+ 12 AU 0.000 0.000 98.725 0.000 0
+ 12 SE 98.940 98.950 98.940 0.000 54050
+ 12 DE 98.980 98.990 98.980 0.000 49142
+ 13 MR 98.940 98.960 98.940 0.020 33314
+ 13 JN 98.920 98.930 98.910 0.020 23069
+ 13 SE 98.880 98.900 98.880 0.010 4780
+ 13 DE 98.860 98.870 98.850 0.020 1467
+ 14 MR 98.820 98.840 98.810 0.020 960
+ 14 JN 98.770 98.780 98.760 0.210 571
+ 14 SE 98.710 98.730 98.690 0.020 101
+ 14 DE 98.650 98.670 98.630 0.020 83
+ 15 MR 98.580 98.600 98.580 0.010 136

I personally don’t see it happening – Mark Carney is going to hold pat at 1%.

The following is a chart of 1-year Canadian treasury note yields:

What I find interesting is that just a month ago the market was pricing in a significant increase of interest rates – something flipped like a switch, and this is undoubtedly due to the theatrics going on in Europe at the moment. Big players are raising cash and this is depressing asset prices.

Still not buying anything

Despite having over a 70% cash position at present, I still remain highly skeptical of the marketplace. Although I am happy to see things dive down another 4% on the major indicies (2% on the TSX), the root causes of this mayhem have not been addressed at all yet. I still highly suspect there is more to come. There will continue to be gut-wrenching rallies up and crashes down and today is an example of a crash down. The next two hours of trading can change everything, but the mid-term trend is clearly down. Although mathematically volatility is “up and down”, it strongly correlates with a down market when buying volatility futures!

However, when looking at the numbers, today’s dump feels less liquidity-inspired than the previous dump (where everything was getting thrown out the window if there was a bid). I do notice that certain fixed income products have been able to outperform (by falling less) and also Canada has fallen less unless if you are invested in the natural resource sector (commodities have been hammered). Typical defensive issues (e.g. consumer staples) have also fallen less than commodity-linked products.

My entire premise for this market drop is a combination of a grave concern on a macroeconomic scale (i.e. a pending devaluation of the US dollar) with a deleveraging of portfolios – you can only borrow at 1-2% and purchase income-oriented securities for so long before the capital value of such income-oriented securities suddenly take a plunge and then you have to deal with the margin call of the decade to truly pay for it.

While we are on the topic of interest rates, Canadian short term implied rates have also projected a chance of a rate cut by years’ end:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 11 SE 98.780 98.785 98.755 0.025 5322
+ 11 OC 0.000 0.000 98.725 0.000 0
+ 11 NO 0.000 0.000 98.805 0.000 0
+ 11 DE 99.020 99.030 98.910 0.110 16290
+ 12 MR 99.120 99.130 99.000 0.120 21771
+ 12 JN 99.150 99.160 99.010 0.140 11273
+ 12 SE 99.140 99.150 98.980 0.170 4853
+ 12 DE 99.130 99.140 98.950 0.190 2782

A December BAX rate of 99.02 corresponds to a rate of 0.98%, which should be compared to a 1.18% rate for 3-month Bankers’ Acceptances – the markets are predicting a higher chance of a rate cut than not.

Bank of Canada to cut interest rates?

I notice that December BAX futures are pricing in a rate decrease by the Bank of Canada to 0.5 to 0.75%:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 11 AU 0.000 0.000 98.880 0.000 0
+ 11 SE 98.890 98.895 98.895 0.000 23059
+ 11 OC 0.000 0.000 98.865 0.000 0
+ 11 DE 99.140 99.150 99.150 0.000 50455
+ 12 MR 99.140 99.160 99.170 -0.020 32592
+ 12 JN 99.140 99.150 99.170 -0.030 17723
+ 12 SE 99.110 99.120 99.140 -0.040 6277
+ 12 DE 99.050 99.070 99.090 -0.020 1582

Indeed, the only people making any money out of the marketplace right now are those that have been holding onto long-term government bonds, an instrument that almost everybody stated couldn’t go lower in yield.

Government Bond yields have dropped significantly

The one impact of the US debt ceiling extension has been that government bond yields have dropped significantly over the past week. For instance, the 10-year Canadian government bond benchmark has lost about 25 basis points which is a huge drop:

10-year bond yields are now lower now than they have been since January 2009 (the depths of the financial crisis). The bond markets are highly pessimistic about any form of economic recovery and are trading as such.

Short term rates are no longer pricing in a sure chance of a rate increase – BAX futures are as follows:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 11 AU 0.000 0.000 98.670 0.000 0
+ 11 SE 98.685 98.690 98.685 0.000 23202
+ 11 OC 0.000 0.000 98.655 0.000 0
+ 11 DE 98.660 98.670 98.660 0.010 42832
+ 12 MR 98.630 98.640 98.610 0.020 35992
+ 12 JN 98.590 98.610 98.560 0.040 16408
+ 12 SE 98.550 98.570 98.510 0.050 7649
+ 12 DE 98.500 98.510 98.450 0.060 2729

The December BAX Futures are at 98.66 (1.34%) compared to 98.46 (1.54%) when the Bank of Canada made its last pronouncement on short term rates.  It no longer appears that short term rates will be rising at all.  Three month corporate paper is still at 1.17%.  If there is any hint of economic recovery, it is not seen in the bond market.

Bank of Canada keeping rates steady

The Bank of Canada has kept the target overnight interest rate steady at 1%. This surprised nearly nobody. Their statement is relatively unchanged from the prior one.

The chart to keep looking at is not the BAX futures, but rather the 10-year benchmark government bond yield:

With the yield spread from short-term rates to the 10-year at about 205 basis points, the bank is unlikely to lift rates anytime soon.

BAX futures are as follows:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 11 JN 98.695 98.705 98.695 0.005 12727
+ 11 JL 0.000 0.000 98.630 0.000 0
+ 11 AU 0.000 0.000 98.615 0.000 0
+ 11 SE 98.630 98.640 98.630 0.000 31347
+ 11 DE 98.500 98.510 98.480 0.020 37387
+ 12 MR 98.350 98.360 98.310 0.040 24564
+ 12 JN 98.200 98.210 98.140 0.060 13081
+ 12 SE 98.040 98.050 97.970 0.070 3855
+ 12 DE 97.870 97.890 97.790 0.090 809

The market has priced in a rate hike by year’s end, but I do not think this projection will come to fruition – come December, the 98.5 price will be likely around 98.7 – a thin value bet could be placed here.

Canadian Interest Rate Futures

Examining the short-term interest rate expectations of the futures market:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 11 AL 0.000 0.000 98.710 0.000 0
+ 11 MA 0.000 0.000 98.640 0.000 0
+ 11 JN 98.660 98.665 98.670 -0.005 17877
+ 11 SE 98.490 98.500 98.500 0.000 25173
+ 11 DE 98.310 98.320 98.310 0.000 32785
+ 12 MR 98.130 98.140 98.140 0.000 15601
+ 12 JN 97.950 97.970 97.960 -0.010 4616
+ 12 SE 97.770 97.790 97.790 0.000 945
+ 12 DE 0.000 97.640 97.610 -0.030 648

The Japanese earthquake and general instability in the marketplace has driven the June futures up from 98.545 on March 1st to 98.66 today – which is pricing in a small chance that the Bank of Canada will increase interest rates on their May 31 interest rate announcement. It is far more likely that the short term rate will be 1%.

The futures still anticipate that the year-end short-term rate will be 1.5%, so it will be interesting to see if this comes to fruition. With reports of food inflation rising (primarily due to commodity price increases), the Bank may have to make an undesirable decision to raise interest rates to stem inflation, which would have an adverse effect on the economy and stock markets.

I stated earlier I do not expect the Bank of Canada to raise interest rates until 10-year government bonds go above 3.5%, and they are presently at 3.19%:

Notably, the Canadian 10-year bond is trading at a yield of 10bps less than the US 10-year note.

Bank of Canada leaves rates at 1%

As predicted, the Bank of Canada leaves rates at 1%, citing:

The recovery in Canada is proceeding slightly faster than expected, and there is more evidence of the anticipated rebalancing of demand. While consumption growth remains strong, there are signs that household spending is moving more in line with the growth in household incomes. Business investment continues to expand rapidly as companies take advantage of stimulative financial conditions and respond to competitive imperatives. There is early evidence of a recovery in net exports, supported by stronger U.S. activity and global demand for commodities. However, the export sector continues to face considerable challenges from the cumulative effects of the persistent strength in the Canadian dollar and Canada’s poor relative productivity performance.

While global inflationary pressures are rising, inflation in Canada has been consistent with the Bank’s expectations. Underlying pressures affecting prices remain subdued, reflecting the considerable slack in the economy.

This language is similar to the previous release, and suggests that at the April 12th release that the Bank of Canada, barring any major events between now and then, will be keeping rates steady at 1% for that meeting.

BAX Futures are a shade higher, although it should be noted that the June future is at 98.545, implying a coin toss for a 0.25% rate hike at the May 31, 2011 announcement.