Category: Canada

On the March 2, 2022 interest rate announcement, the Bank of Canada stated:

The policy rate is the Bank’s primary monetary policy instrument. As the economy continues to expand and inflation pressures remain elevated, the Governing Council expects interest rates will need to rise further. The Governing Council will also be considering when to end the reinvestment phase and allow its holdings of Government of Canada bonds to begin to shrink. The resulting quantitative tightening (QT) would complement increases in the policy interest rate. The timing and pace of further increases in the policy rate, and the start of QT, will be guided by the Bank’s ongoing assessment of the economy and its commitment to achieving the 2% inflation target.

My guess is that the April 13 announcement will involve a 1/4 point increase, coupled with some QT.

As of today, the Bank of Canada has $431 billion in securities (422 billion in government debt and 9 billion in mortgage securities) to work off their balance sheet. I very much doubt they will get that far.

Right now, they are in the reinvestment stage – as maturities arrive, proceeds are invested in other treasury securities. You can view the results of such actions here.

The term structure of their debt is skewed short – the median term is 4 years.

Bank of Canada government debt holdings by maturity

April 3, 2022

Year	Par (millions)
2022	$56,945
2023	$88,549
2024	$53,992
2025	$43,082
2026	$37,035
2027	$12,843
2028	$8,435
2029	$12,760
2030	$34,309
2031	$14,635
2032	$340
2033	$5,075
2034	$-
2035	$-
2036	$440
2037	$7,645
2038	$-
2039	$-
2040	$-
2041	$7,309
2042	$-
2043	$-
2044	$425
2045	$8,911
2046	$-
2047	$393
2048	$6,371
2049	$-
2050	$76
2051	$17,947
2052	$-
2053	$2,801
2054	$-
2055	$-
2056	$-
2057	$-
2058	$-
2059	$-
2060	$-
2061	$-
2062	$-
2063	$-
2064	$2,128

What is likely to happen is that the Bank of Canada will prescribe an amount to be bled off the balance sheet and then as debt securities come up for maturity, the reinvestment will be at a lower amount.

When QE ended (October 27, 2021), the Bank of Canada was purchasing $2 billion in incremental debt per week. It was as high as $4 billion per week during the Covid crisis in 2020. I suspect the wind-down will be at a pace of $2 billion a week.

The effect of QT should be the overall rising of interest rates across the yield curve as the Bank of Canada will be picking up less of the government debt market – this slack will have to be picked up by the external markets. We have already seen a significant rise up in the yield curve – for example, the 5-year rate has risen from 1.25% at the end of 2021 to about 2.50% today. The rise in interest rates has an equivalent impact on the discounted rates of assets (i.e. assets with future-dated cash flows will trade lower all things being equal). Also, note the US Federal Reserve will likely engage in their own form of QT soon (likely early May), this will create an ever-tightening monetary climate. There is still plenty of excess liquidity out there in the system, but over time this will be shrinking. Be cautious.

The geopolitical/economical climate is changing so fast that it is giving me a very difficult time trying to piece together what the sense of reality is out there.

Globe and Mail article: Canada to boost energy exports to U.S. to aid in supply crisis triggered by Russia’s war in Ukraine

Canada says its producers can boost exports of oil and natural gas to the United States this year, as part of an international effort to help the world move away from Russian energy after Moscow’s invasion of Ukraine.

…

“It will take some time to fully move away from Russian oil and gas for some of these countries like Germany that are quite heavily dependent,” [Minister of Natural Resources] Mr. Wilkinson said. “Any additional amounts can help to start that process.”

There is no way such a statement would ever be made inadvertently by a cabinet minister.

This is what I consider to be a political “trial probe”. If there is no outrage by the constituent groups that aren’t already organically opposed to this (e.g. Sierra Club, Greenpeace, etc.), it will proceed.

It is the oil and gas companies themselves that choose how much to produce, but if this particular government is back-peddling on their hostility (which can be characterized as extremely hostile to simply hostile), analysts will most definitely warrant a multiple re-rating to account for mild less uncertainty on this government that will “phase out fossil fuels”.

Things are turning. Watch out for the turn, we are in the middle of it.

(Link: BoC interest rate announcement)

The Bank of Canada surprised somewhat with a non-change in interest rates, but giving obvious forward guidance that rates next meeting are likely to head higher. Today’s BoC meeting is coincidentally aligned with the US Federal Reserve meeting, which also held pat, but announced they were going to stop the additional purchases of government and mortgage-backed debt starting in March.

The two key sentences are in the last part of the Bank of Canada statement:

The Governing Council therefore decided to end its extraordinary commitment to hold its policy rate at the effective lower bound. Looking ahead, the Governing Council expects interest rates will need to increase, with the timing and pace of those increases guided by the Bank’s commitment to achieving the 2% inflation target.

The Bank will keep its holdings of Government of Canada bonds on its balance sheet roughly constant at least until it begins to raise the policy interest rate. At that time, the Governing Council will consider exiting the reinvestment phase and reducing the size of its balance sheet by allowing roll-off of maturing Government of Canada bonds.

This suggests that the target rate will rise (from 0.25% to 0.5%?) on March 2nd, coupled with a slow rollback of their ~$450 billion balance sheet of government and provincial bonds.

The interest rate futures markets were somewhat surprised at the non-rate rise:

… the prices are implying a 1% increase in rates by the end of the year and another quarter-point in early 2023.

One other observation is that the 5-year government bond yield is down to about 160bps – it got up to about 170bps last week which is the highest it has been in some time (great for those rate-reset preferred shares if they’re due to be reset soon – about 50bps higher than they were 5 years ago).

Within the monetary policy report, some items of note:

The neutral nominal policy interest rate is defined as the real neutral rate plus 2% for inflation. The neutral real rate is defined as the rate consistent with both output remaining sustainably at its potential and inflation remaining at target, on an ongoing basis. It is a medium- to long-term equilibrium concept. For Canada, the economic projection is based on an assumption that the nominal neutral rate is at the midpoint of the estimated range of 1.75% to 2.75%. This range was last reassessed in the April 2021 Report.

Notably with the above, the market is predicting an interest rate at the lower range.

Consumer price index (CPI) inflation is expected to be higher than projected in October. The outlook for CPI inflation in 2022 is revised up by about three-quarters of a percentage point to 4.2% and remains unchanged in 2023 at 2.3%. This upward revision mainly reflects larger impacts from various supply issues, notably those affecting shelter costs and food prices.

The projected CPI will continue to make headlines as the monthly reports come in. Considering the huge price spikes on the inputs to consumer supply (energy, wood, metals, etc.) it is difficult to see how costs will not be rapidly increasing in the future – especially considering the other component – which is human know-how – will be rapidly rising in price as well, likely in excess of commodity prices themselves.

And in what I consider to be the award for the month for the “most unnecessarily complex data visualization”, we have the following gem:

Should anybody be shocked that the purple #1 (upper-left hand side) represents “Employment level index, public sector”?

Here is my take-away: The Bank of Canada is heavily anticipating that things will ‘correct themselves’ through two effects – supply chain resolution, coupled with restoration of global conditions (allowing for exports). They assume domestic spending and consumption will resume as the Covid effects abate, and this will drain the accumulation of savings that were distributed in the past couple years.

I don’t see it this way. The separation of employment characteristics, for example, by age/gender and “public sector”, and “mid-high wage”, does not tell the story at all. It is very much unexplained (at least in the eyes of the Bank of Canada) why there are persistent labour shortages. The most obvious explanation is that what is being offered vs. the headaches of employment compared to what such employment purchases is out of proportion. In other words, wages need to rise dramatically, or what the existing wages can purchase need to increase – the latter case is not going to happen due to continual monetary debasement. People are basically deciding to exit the game – and some perhaps are becoming full-time cryptocurrency traders.

The best thing the central banks can do is engage in a massive monetary draining. The bitter pill would last a couple years, similar to what former FOMC chair Paul Volcker did when he raised interest rates into the double digits in the late 70’s and early 80’s. This facilitated a monetary cleansing. The central banks will not do this, one reason being it would collapse the asset markets and given the amount of debt that is collateralized by such asset values, will cause a huge amount of financial disruption.

Posted below are 50 companies with a market cap over $50 million (i.e. weeding out those that actually went completely bust during the year) that have the worst year-to-date stock performances from 2021. I also include a short one-liner description of these companies and/or quick thoughts. This is as of closing prices on November 12, 2021.

Themes / Notes:
The “top 50” lost 72% to 36% of their market value during the year;
Gold mining or shiny metal companies (whether they actually are operating or theoretical) populate 20 of 50 of these;
Bio/pharma (or medical instrumentation) companies were 8 of 50;
Cannabis and related are 7 of 50;
Hydrogen or “clean energy” are 4 of 50.

When looking at these 50, there were none of them that passed my own personal screens for being worthy of a watchlist placement. Your mileage might vary. There is no “best of the worst” here, I really don’t like this year’s crop of tax loss candidates, at least the top 50.