Back on October 7, I wrote the following:
Until things blow up, my nominal trajectory for Canadian short-term interest rates will be:
October 26, 2022 – +0.50% to 3.75% (prime = 5.95%)
December 7, 2022 – +0.25% to 4.00% (prime = 6.2%)
January 25, 2023 – +0.25% to 4.25% (prime = 6.45%)
March 8, 2023 – +0.25% to 4.50% (prime = 6.7% – think about these variable rate mortgage holders!)Note that the Bankers’ Acceptance futures diverge from this forecast – they expect rate hikes to stop in December.
We might see the Canadian 10-year yield get up to 375bps or so before this all ends, coupled with the Canadian dollar heading to the upper 60’s.
This October 26 prediction was a non-consensus call, with the markets generally pricing in a 75bps increase and me sticking my neck out with 50bps. I nailed it.
The 10-year government bond yield did eclipse 3.75% on October 21, but I am not claiming victory here – the intention of my post is that it will be occurring later in the future when it dawns into the market that short term rates are not dropping.
The Canadian dollar clearly hasn’t gone into the 60’s yet, but it should happen.
I get the general sense that the market is pricing in a change in the second derivative of the interest rate trajectory. The pattern looks very elegant – 25bps, 50bps, 50bps, 100bps, 75bps and now 50bps, and they expect another 25bps in December and then it’s done. Since the light can be seen at the end of the tunnel, party on, start playing the low interest rate trade since surely the Bank of Canada and Federal Reserve is going to loosen policy again and send everything skyrocketing.
It will not be this simple. Long term bond yields will rise and markets will fall when they come to the realization that inflation has not subsided.
Recall that inflation is not increased prices, but rather the expansion of money supply against a fixed amount of goods and services. Increased prices are a consequence of inflation.
The reason is that this assumption that market participants believe that central banks will come to the rescue in the event the economy tanks is what is causing the rates to continue increasing. It will only be when people are begging and pleading for relief that the central banks will relent, and likely bail out the entire populace with the introduction of a centrally administered digital currency.
The key metric to watch out for is employment. Although full employment is the mandate of the US Federal Reserve, it is something that the Bank of Canada will be paying attention to, albeit a lagging indicator.
We need to see unemployment rates climb before the psychology of inflation gets stabbed in the chest.
Until then, every item purchased at Costco and Walmart, every restaurant meal, every hotel and airline ticket, represents an element of aggregate demand which the supply is clearly still not expanding to.
There are signs that the tightening monetary environment is having an effect. Monetary aggregates have barely budged over the past year (M2++ is up 1.4% from January 1 to August 1 this year when the typical trendline is around 5%). But we are in a waiting period where corporations and individuals need to burn off their reserves before engaging in the real difficulty of belt-tightening that comes after some very poor fiscal and monetary decision-making.
Using a physical analogy, we have been eating daily at a buffet for the past two weeks and the 10 pounds of excess weight that we have gleefully put into our stomachs need to get worked off. Although the food has been taken away relatively quickly (rising interest rates), the fat on the waist is still showing (we still have a huge surplus of liquidity from the 2020-2021 fiscal/monetary actions).
Until we see signs of unemployment and, in general, “pain”, interest rates will slowly climb until we see people lose jobs. The Bank of Canada governor is slowing things down for political reasons more than anything else – he doesn’t want to be seen as the guy crashing the economy – and you can be sure that politicians of every political stripe, whether red, blue, orange, light blue or green, will be sharpening their knives and polishing their talking points.