Short-term Canadian Interest Rates

The Bank of Canada’s next interest rate decision will be on May 30th.

Pundits are saying the bank will stand pat, citing various economic statistics, trade uncertainty with NAFTA, lunar cycles, etc.

There is one other statistic that matters much more than others, and it is the following chart (10-year government bond yield):

As long as the spread between short-term rates and the 10-year yield remains greater than a percentage point, this gives them clearance to raise rates, especially when lock-step with the Federal Reserve.

My prediction, if it wasn’t obvious by the tone of the previous writing is, that barring some major change or news over the next week, the Bank of Canada will raise the short-term target rate to 1.5% (up 0.25%) on May 30th of this year.

Right now the 3-month Bankers’ Acceptance is at 1.69% which translates into 98.31 on the futures contract. Currently the June 2018 BAX Futures are trading at 1.81% (98.19), which also factors in some interest rate probability concerning the July 11, 2018 decision.

(Update, May 29, 2018: Given that 2, 5 and 10 year rates have dropped significantly in the past week, I’m withdrawing my prediction. Next cycle will depend on the rate spread between short-term and 10-year yields.)

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.