Tag: BAX

I notice that the Banker’s Acceptances have dropped (implying future rate increases) over the past week. Current quotations are as follows:

Month / Strike	Bid Price	Ask Price	Settl. Price	Net Change	Vol.
+ 10 OC	0.000	0.000	98.640	0.000	0
+ 10 NO	0.000	0.000	98.630	0.000	0
+ 10 DE	98.615	98.620	98.650	-0.030	12401
+ 11 MR	98.450	98.460	98.520	-0.060	21511
+ 11 JN	98.380	98.390	98.450	-0.070	6701
+ 11 SE	98.310	98.320	98.380	-0.060	2617
+ 11 DE	98.250	98.260	98.310	-0.050	1526
+ 12 MR	98.190	98.220	98.240	-0.040	99
+ 12 JN	98.090	98.130	98.150	-0.030	7

Look at the December contract – implied pricing of 1.39%. On September 8th, this was 1.14%.

Three-month corporate paper is currently trading at 1.14%, which implies that we could be seeing one more rate hike (of 0.25%) before year’s end. The next Bank of Canada scheduled rate announcements are October 19 and December 7.

At 9am (eastern time) on September 8th, the Bank of Canada will make an announcement regarding the overnight target interest rate, which is currently 0.75%. The 3-month Bankers’ Acceptance futures market currently has the following quotations:

Month / Strike	Bid Price	Ask Price	Settl. Price	Net Change	Vol.
+ 10 SE	98.895	98.900	98.890	0.000	16669
+ 10 OC	0.000	0.000	98.795	0.020	0
+ 10 NO	0.000	0.000	98.785	0.020	0
+ 10 DE	98.850	98.870	98.850	0.010	19389
+ 11 MR	98.760	98.770	98.750	0.010	12911
+ 11 JN	98.670	98.690	98.650	0.020	6078
+ 11 SE	98.550	98.570	98.530	0.020	3172
+ 11 DE	98.400	98.430	98.400	0.110	363
+ 12 MR	98.270	98.310	98.270	0.100	262

A September and December contract at around 98.85-98.9 is projecting that there is a higher than average chance of a 0.25% rate increase this upcoming meeting, and then no further rate increases for the rest of 2010.

The market is likely going to be correct with this – I anticipate a statement that will state that domestic growth in Canada is quite good, but there remains significant risks outside the country that might affect Canada’s domestic economy.  A 1% short term rate, historically, is still very stimulative.

3-month corporate paper is yielding 0.98% on September 7th and 3-month T-Bills are yielding 0.78%.

In the last decade, the previous low bank rates were 2.25% in early 2002 and in the middle of 2004.

The main impact of the sum of these interest rate increase decisions is that the yield curve will be slightly less steep – traditionally banks make money by borrowing short and lending long.  So when rates were at 0.25%, they could borrow money at that rate, and then lend it out (the ultimate risk-free loan would be to the Government of Canada, which has a 10-year bond yield currently of 2.95%).  You would then skim the difference (2.7%) as profit, which is nearly risk-free.

By increasing interest rates, spreads shrink somewhat.  Assuming the Bank of Canada does raise rates to 1%, the spread will shrink to 1.95% for 10-year money which is still profitable, but not quite as profitable as it was at lower rates.

People with sensitivity to short-term rates (e.g. variable rate mortgages, margin balances in margin accounts) will feel the impact of this increase most directly.

Looking at Banker’s Acceptance Futures, we have the following rates:

Month / Strike	Bid Price	Ask Price	Settl. Price	Net Change	Vol.
+ 10 SE	98.915	98.930	98.925	0.000	16053
+ 10 OC	0.000	0.000	98.830	0.000	0
+ 10 NO	0.000	0.000	98.820	0.000	0
+ 10 DE	98.890	98.900	98.900	0.000	27314
+ 11 MR	98.820	98.830	98.830	0.000	25451
+ 11 JN	98.740	98.750	98.750	-0.010	8618
+ 11 SE	98.600	98.620	98.610	0.010	1774
+ 11 DE	98.480	98.520	98.490	0.020	1197
+ 12 MR	98.360	98.440	98.370	0.060	386

It looks like that there will be a higher than 50/50 probability that the Bank of Canada will raise their overnight target rate by 0.25% in their September meeting, but after that, future rates in the 2011 calendar year are projected to go up by 0.25% to 0.5%.

The drop in increase expectations has likely contributed to depreciation of the Canadian currency – currently at 94 cents US to a Canadian dollar, while this was high as 98 cents earlier in August, and at parity back in April.  During the depths of the economic crisis, the Canadian dollar reached 78 cents multiple times throughout the October 2008 to March 2009 period.

Since the last 0.25% rate increase on July 20, the bankers’ acceptance futures have been quite calm. We have the following quotations:

Month / Strike	Bid Price	Ask Price	Settl. Price	Net Change	Vol.
+ 10 AU	0.000	0.000	98.905	-0.005	0
+ 10 SE	98.825	98.835	98.825	0.000	1825
+ 10 OC	0.000	0.000	98.725	-0.005	0
+ 10 DE	98.700	98.710	98.700	0.010	6190
+ 11 MR	98.580	98.590	98.580	0.010	4636
+ 11 JN	98.460	98.470	98.460	0.010	2213
+ 11 SE	98.310	98.320	98.310	0.000	904
+ 11 DE	98.140	98.150	98.130	0.010	303
+ 12 MR	97.950	97.960	97.940	0.020	104
+ 12 JN	97.770	97.790	97.760	0.020	54

This still hints that the short term rate will rise 0.25% by the September 8 or October 20 meeting, and the short term rate will end the year at 1.00% with a possibility of 1.25%. For the year 2011, rates are expected to inch higher by about 0.5 to 0.75%.

It should also be noted that at present, 3-month corporate paper is yielding 0.89%. This was approximately 0.4% half a year ago.

Finally, since 5-year bond rates have dropped considerably over the same time period (which is counter-intuitive to the economics 101 texts that state that longer-term bond yields will rise with an increase in interest rates), 5-year fixed term mortgages should also drop – the best one I can see so far is 3.87%.

On July 20, the Bank of Canada is very likely to increase the overnight target interest rate from 0.50% to 0.75%; this has already been baked into the marketplace. The Prime Rate is likely to correspondingly increase from 2.5% to 2.75%.

In terms of what lies ahead in the future, we look at the only financial product in Canada that one can use to predict such rate changes, the 3-month Bankers’ Acceptance Futures:

Month / Strike	Bid Price	Ask Price	Settl. Price	Net Change	Vol.
+ 10 JL	0.000	0.000	99.045	0.030	0
+ 10 AU	0.000	0.000	98.960	0.030	0
+ 10 SE	98.875	98.880	98.880	-0.005	10612
+ 10 DE	98.700	98.710	98.710	-0.010	20474
+ 11 MR	98.540	98.550	98.540	0.000	17714
+ 11 JN	98.350	98.360	98.360	0.000	10038
+ 11 SE	98.140	98.150	98.140	0.080	2281
+ 11 DE	97.890	98.110	97.890	0.080	209
+ 12 MR	97.580	97.700	97.680	0.000	341
+ 12 JN	97.370	97.490	97.430	0.090	0

What we see is a 3-month future rate of 1.12% in September; and by years’ end we have a 1.29% rate.

There are four more meetings left in 2010; July 20, September 8, October 19 and December 7.  Right now, the market is speculating that there will be 0.25% increases in two of these meetings, leading to a year-end target rate of 1.00%.  It is possible that after September 8, that the Bank of Canada will leave short term rates unchanged for the duration of the year.

In 2011, the market believes that the short term rate will increase by about 0.75% above this; to 1.75%, still a very low rate by historical standards.

Presumably after its July20 statement it will change the language which will sufficiently guide the marketplace to adjust its prices.

Of note is the impact on mortgage rates; only variable-rate mortgages will be going up as a result of these short-term rate increases.  The reason is because longer-term rates are set by the marketplace, and these have gone down over the past quarter.  A 5-year government bond yields 2.49% currently; this was as high as 3.2% back in April.