It’s Finally Over - Views from the North

Ben Reitzes:

Welcome to Views from the North, a Canadian rates and macro podcast. This week I'm joined by Joel Prussky, BMO's OIX and Cross-Currency Trader. This episode is titled "It's Finally Over."

I'm Ben Reitzes and you're listening to Views from the North. Each episode I'll be joined by members of BMO's thick sales and trading team to bring you perspectives on the Canadian rates market and the macro economy. We strive to keep the show as interactive as possible by responding directly to questions submitted by our listeners and clients. We value your feedback, so please don't hesitate to reach out with any topics you'd like to hear about. I can be found on Bloomberg or via email at Benjamin.reitzes@bmo.com. That's benjamin. R-E-I-T-Z-E-S @bmo.com. Your input is valued and greatly appreciated.

Joel, it's been longer than usual since I've had you on here.

Joel Prussky:

Well, a few gray hairs and a few more wrinkles let's say.

Ben Reitzes:

Well for me I think actually, but yeah, and we have the Bank Canada next week, so they are very topical and we've had a lot of top tier Canadian data in the past few days and weeks. So heading into next week's policy meeting, having just gotten CPI this morning, it's currently Tuesday around lunchtime. And we got the business outlook survey yesterday. Where do you see the bank next week? And then, maybe you want to expand on where you see them going for the next few meetings, or as far as you want because I know you have an opinion on everything.

Joel Prussky:

Thanks Ben, and it's a pleasure to be back. So let's talk about the bank. I mean, I've always been a big believer as you got to follow the bank speak. You have to listen to the bank. I think a lot of people wind up getting themselves in holes by looking at the data, but ignoring what the central bankers are telling them. And let's just take The Fed's message of the last two weeks has been very consistent. Rates are high enough for now. I think, after the business outlook survey, which I think was not good. Growth is zero in this country basically. And now, we finally have inflation starting to trend down.

So up until this morning I would've thought October was a 50/50 proposition and lo and behold, we went into CPI priced at 50/50 CPI did well on all metrics, I think as far as the Bank Can is concerned, it's moving lower. It was lower than expected and it moved, which is good. And we instantly repriced October down about seven basis points or eight basis points. And now we're going in at kind of 507-ish, which you could argue what percentage is that? It depends where core... Core has been coming in a little hot lately, a little higher, but if we average 501, that's 6 out of 25 basis points and you can do the math on that.

Ben Reitzes:

24%.

Joel Prussky:

Oh, thank you Jess.

Ben Reitzes:

I did the math.

Joel Prussky:

I still think that's high. I don't know why the Bank of Canada would feel the need to hike rates at this particular meeting. I think there's only one reason and that's to establish his credentials as a bonafide hawk and someone who was going to get the job done no matter what. Although, I just don't see why he would feel the need for that because things are actually starting to go his way.

I think if inflation was as expected or slightly higher, it would be a different story. Or if we're sitting here in March and we have trouble getting from 4 to 3, or from 5 to 3 or whatever that magic number is, maybe then he gets to that point where he says, "Okay, we need a bit more." But that's going to depend on how good growth is, what employment figures look like.

And I mean anecdotally, and I think you are in the same camp, we see housing slowing. We hear stories of that. Airfares, which were ridiculously priced only two months ago, I mean now you can fly to BC for 400 bucks. I mean 400 bucks, you couldn't fly out of Hamilton for $400 a little while ago. So I do think you're starting to see demand wane. People are starting to view inflation as a tax. And I think the one hawkish thing in the BOSs survey was people still want to get made whole for the one-time increase in prices that happened. So there is going to be a bit of a lag of, "Hey, wait a minute, where's mine?"

Ben Reitzes:

So that then begs the question, we know the economy's weakening, like zero growth over six months to July. Business Outlook Survey says it's not getting any better, it's probably actually getting worse. Inflation is coming down, but it's still much too high. And then you have people, and I mean I totally get it, that want to be paid back or made whole for the two years of whatever, 4 to 8% inflation. And so, they want a chunky raise. And I suspect, in some cases, we'll definitely see that at least to some extent. Can the Bank of Canada afford to back off at all from the hawkish tone and start to open the door to looser policy? Or do they have to maintain the optionality to hike in order to keep the market from pricing in more aggressive rate cuts-

Joel Prussky:

That one.

Ben Reitzes:

Next year?

Joel Prussky:

That one. I don't think you'll ever see a dovish hold by the Bank of Canada. I don't think they're capable of it. I don't think any central bank is actually capable of it because they know the signal to a dovish hold is an effective immediate easing over the next 48 hours or week. Well, it is. I mean belly yields would instantly rally 35 or 40 basis points.

And I mean if you really listen to what the Fed has said, which is this steeper and cheaper belly led selloff is an effective hike. I mean, you can't characterize it as anything other than that. We've had mortgage rates basically across the board go up to 50 basis points in the last month. That affects so many people. And I still think there's a ton of people who are in the middle of negative AMs and don't even understand what they've signed up for and then their rate's going to reset and their payments are going to be three times what they were. And when that starts to bite, and that's only just starts to bite, you have a huge percentage of the population that's over levered. And you are going to see cutting back on all sorts of other things, whether it's going out, shopping all this other stuff.

Ben Reitzes:

So I'm going to play devil's advocate even though I don't believe what I'm going to be saying, but that's fine. Only about 35 to 40% of households have a mortgage, so 60% of the population doesn't. That being said another, it's actually lower 30, it's not even 35%, it's 30 to 35% have a mortgage. 35 to 40% are renters and the impact on them is incremental. It's kind of slowly, but surely. I think that's actually going to play out for probably a number of years as rents catch up to where prices are. Or prices come down and the carry cost on all these properties makes a little bit more sense compared to what we've done in Canada for the past 10 years where it's been negative carry, and relying on the appreciation of the property to entice buyers. Is the hit going to be enough to hammer the economy?

Joel Prussky:

I guess the question is do the non- mortgagees or net savers or ….

Ben Reitzes:

So you?

Joel Prussky:

Me.

Will the savers be happy that they're finally getting 5% in a risk-free rate and will that help generate enough income to make up for what the loss is on the people who are, or even the young people? Because you're talking about the young people generation I assume.

Ben Reitzes:

Yeah.

Joel Prussky:

I haven't looked at it that way, but it must be the young people who have mortgages and are over levered compared to the boomers or the people like me.

Ben Reitzes:

That would be the bulk of it, yes.

But I mean the question I guess for you is do you put money in a GIC, or are you buying more Jordans? And so, for me, that's probably the bigger question for the economy is like, okay, so well you do have the hit from the mortgagers. I agree. The resets are going to be significant. Payments may not double or triple, but they're going to be up substantially in a number of cases for the negative and people a ton really. And then on top of that, you have rates that we haven't seen for over 20 years and attractive bond yields, attractive GIC rates. And it no longer makes sense to spend all your money. When rates were zero it's like, "Well, I can't get anything for my money anyways. I might as well just keep..." The incentive is to spend your money, all of it because you get nothing for it if you wait.

Joel Prussky:

And the government keeps giving you more.

Ben Reitzes:

And well there's that, but I'm not going to go there.

Joel Prussky:

Okay.

Ben Reitzes:

Now instead of spending all your money, maybe you can save a little and look, oh, I get 5%, this isn't bad. And that sucks a little bit more out of spending. And I think maybe that's part of also, you get both dynamics going on where people that aren't necessarily hit hard by the higher rates are attracted by higher rates. And you know what? I don't want to spend as much. I actually want to save Because getting something for my savings. And then, the people that have to pay those higher rates are like, "Well obviously I need to tighten my belt here to afford these payments."

And so, I think the both sides of that equation are why we're at zero growth over six months. Because if you just run the numbers on the mortgage resets, it doesn't have to be crushing. It actually just isn't. And you can go out there and run the numbers yourselves. It doesn't have to destroy the... In aggregate, it doesn't destroy the economy, but you put everything together and I think that's why we are where we are. That's why consumption growth was quite weak in the second quarter and probably continuing to be weak in the third quarter. And I don't see that changing either in the fourth quarter. And that, in turn, helps the inflation equation and so on and so forth. And that's how I think we get to the happy place of 2% inflation maybe.

Joel Prussky:

I mean look, that makes a lot of sense. I do think there's also the intergenerational wealth transfer that probably gets accelerated a bit in the sense that you talk about boomer parents whose house is paid off, who are now earning money. And now their kid comes to them and said, "Shoot dad, I took this mortgage out, I was paying 1200 bucks a month for my condo and now it's like 2200 bucks a month and could you help me out a bit?" So I think part of what you paint there helps hasten some of that intergenerational wealth transfer because the kid's not going to get another 1,000 bucks a month by snapping his fingers.

Ben Reitzes:

Or he just stops spending so much on restaurants and Air Jordans. I mean these are all possibilities.

Joel Prussky:

I wouldn't mind if the price of Jordans went down a bit. We could always use a couple new pairs.

Ben Reitzes:

We could use some disinflation on a whole bunch of things. Or I mean outright deflation on a few things wouldn't be terrible either like lunch, just way overpriced.

Joel Prussky:

Which is now $20 for a salad.

Ben Reitzes:

Almost everything.

Joel Prussky:

Yeah.

Ben Reitzes:

It's unfortunate.

It looks as though we are at the end.

Joel Prussky:

I think so. I mean, I think if you look at not only what's priced for October, but we're still up at almost 518, 520, which is for January, kind of March area, which I wouldn't count the bank out out, but if all of a sudden inflation starts heading in the right direction and growth remains anemic, why in the world would we be at 80% priced of another rate hike? Other than I guess the US got some strong data today.

The difference there is they've priced in cuts much sooner than we do in Canada. And if you look at the Canada versus the US rates, especially in the front end, those COFERs were at minus 35, minus 40 a week ago. They're at minus 13 today. So not only are administered rates in Canada still expected to be higher than the US in a year's time, which I'm not so sure about, but I mean we've already had a fairly big move and that should continue. I don't know why just because the US has strong data, we have weak data that we would continue to price in higher chances of rate hikes down the road.

Ben Reitzes:

So is there a positioning aspect, a liquidity aspect of this that's keeping that 518 rate? Because I agree it's almost totally insane. It's almost like we're pricing the Bank of Canada to just not pay attention to what's going on and there's too much fear at the bank.

Joel Prussky:

So I think there's two things. I mean I think first of all we have to wait to get through the meeting next week. And we have to wait and see what he says. And I think we're going to get a hawkish hold. The question is how hawkish? And on the hawk-o-meter, if it's a 10, which is we're okay now, but we still think there's a better chance we have more to do, well then we're going to stay up there. If we get the, we're pausing, we're vigilant about going if we need to more and things are still heading in our direction, maybe you'll take some of that out.

But most of that stuff is driven by algos and black boxes who, they're trend following systems who relentlessly sell the market based on what's going on in the US. So they are totally oblivious and care not about made in Canadian data. They see is tenure treasuries getting hit today? Are yields going higher? Then we should smack the Canadian market, therefore we'll price in more rate hikes. This has been going on now for the better part of a year and a half. And the market's not deep and liquid like it used to be and there's no other side. And that's what happens and it creates a lot of opportunities at times. The curb gets stretched or Canada/US looks cheap or expensive. I mean the beauty of these blacks boxes is they're single minded in their purpose but they're not very smart.

Ben Reitzes:

So we need to see the US turn to get this kind of normalization in pricing?

Joel Prussky:

I think two things make a turn. One is the US starts to show the same kind of turn in the data as Canadian data has. The other is the Bank of Canada comes out with a message that's powerful enough that fast money and real money say, "Hey, wait a minute, there's good value in receiving the Canadian curve in one year, or two year, or whatever. We want to do that trade not against this, not against that just outright receiving." And then, all of a sudden you've got this entire wall of money that comes in to do that, and it changes the imbalance in the market and the black boxes can do all they want, but the real money will just be there to take it off their hands.

Ben Reitzes:

Yet the bank's going to have to change their tone for that. I think the surprising nature of the Bank of Canada over the past few years has made people very reluctant to do anything other than be afraid of them and fear whichever way is most likely. And will price that side until they fear the other way and they surprise us on the dovish side and one day they just are like, "Just kidding, no more hawkishness. We're done."

Joel Prussky:

It's been global.

Ben Reitzes:

By the way.

Joel Prussky:

It's not a main Canada thing. I mean what we always were bothered by is why up until two weeks ago, would anyone think that Canadian rates would be 50 beeps above US rates in nine months or a year's time? I mean, economically in the data, nothing did that way, but that's a liquidity pressure valve in Canada. That's just a function of that and the market's not like it used to be.

Ben Reitzes:

Yeah-

Joel Prussky:

Banks don't take risks, traders don't take risks. We're risk movers. We're not risk takers. And that's a big difference.

Ben Reitzes:

All right, so it does look like it's finally over on the rate hike side at least, but rate cuts aren't coming anytime soon. I think that's probably the message they want to continue to send.

Joel Prussky:

What is that though? To me, as soon as three to six months.

Ben Reitzes:

I'm with you. But I think they don't even want to have the conversation, not something we're discussing at this point in time.

Joel Prussky:

Nor should it be. But if things do turn and growth starts getting even worse and inflation starts moving faster, the market will get there well ahead of them. But I agree for six months we shouldn't even consider it. But that's not going to stop the market from doing what the market does, which is at some point if you believe that neutral... And again, this goes back to it, did the bank over tighten or was 5% the magic perfect number for the next...? And it might be, I don't know. I mean you only know in hindsight.

Ben Reitzes:

Given the data the way it's unfolding and the lags with which policy work, 5 is probably going to be on the tight side is my guess just simply. And I'd go back to-

Joel Prussky:

When you say the tight side, I mean, the intent was to get tight.

Ben Reitzes:

So go back to June/July, I think the last 50 basis points and in my opinion what prompted them to go, at the time inflation hadn't been a little bit stronger, but it was more that growth was just very resilient and consumption was really strong in the first quarter. And it was just like, "All right, well clearly nobody cares about these rate hikes. We need to do more."

That got revised away a decent amount and the second quarter was pretty terrible, which we didn't have any insight on at the time, but you're already at the end of the second quarter in June pretty much. And you already had the economy stalling for all intents and purposes. And things have only continued to soften since then. And so, that last 50 basis points, I mean hindsight is 2020 and I don't blame the bank for going given the information they had, but it may be looked upon as a policy error a few years down the road in that they shouldn't have done it, but they couldn't have known better. I mean you can only do what you can with the data you have and the data they had, unfortunately, got refunded and that's the way life goes sometimes.

Joel Prussky:

But to me the policy error would be to continue to hike.

Ben Reitzes:

Now it would be crazy.

Joel Prussky:

At this point you could argue, okay, we wanted to get tight, we got too tight. The tight is doing its work and maybe we can have a discussion in March that maybe it's time to get conditions back to neutral or closer to neutral. And the question is what does that really mean? Because I think there's a recency bias where people think that rates could get to 2% again. To me, I think two is the new zero. If there's a horrendous thing happening, we'll go back to 2%, but 0%, it was a crime against finance, it was. And negative rates, I mean don't get started on what happened in Europe. I think it proved that nothing really helped anything. It didn't really fix structural problems. It made people make stupid decisions on capital. And I don't think we're going to go back there again. So to me, 2 is the new 0.

Ben Reitzes:

So how low do we end up going? So I'm writing about this today for my Tuesday weekly. What are the forward curves pricing in Canada? It's like the low is 3.50, 3.60, that's the low in rates and it doesn't stay there for that long. And then it climbs back up to 4%.

Joel Prussky:

Yeah, I mean the climbing backup part is just a mathematical construct of nonsense. But let's get to the low.

Ben Reitzes:

That's fine.

Joel Prussky:

I mean 3.5 is probably not the wrong place. I think we're in a world of structurally higher inflation going forward, which means structurally higher R star. I think green energy transformation, friend-shoring, all that stuff isn't going to go away. So that is ultimately going to be put at least I think pressure on.

Ben Reitzes:

So all those, I've made all those points. All my points, I totally agree with them. However, those are secular arguments and there's a cyclical aspect to all this. So if things get bad enough here, it is not inconceivable that 3.5% low point looks pretty cheap. Once they start cutting at all, I feel like that just comes down in an all flurry and it will have a 2 handle, maybe it's 2.75 or whatever or it'll be 3 at the peak I think realistically.

Joel Prussky:

But part of that's going to depend, I think, on literally something as simple as the supply and demand for bonds because that's what we're getting to now. Why is the curve so steep, or why has it re-steepened so much, why is there no bid for long bonds in America? Not in Canada of course. But I mean there is a lot of financing that needs to get done and there's only so many buyers. And I think, if the stock market crapped out at 20% or 15%, you might see money would be happy leaving equity market and saying, "Hey, let's take these higher yields." And maybe in the scenario you just described, that would be happening anyways.

But globally, at least among the developed world, there is a lot of debt that needs to be rolled over and funded.

Ben Reitzes:

So far, Canada doesn't seem to be having a problem with our lungs 120 through the US today, but that clearly is a Canada specific problem.

Joel Prussky:

And that goes to the supply and demand thing, right?

Ben Reitzes:

Yes.

Joel Prussky:

There's clearly way, way, way too much demand and clearly way, way not enough supply.

Ben Reitzes:

And that has broken the market unfortunately, at least for now. At some point that that'll fix itself. But we'll see. We're not there yet.

Staying on that topic to some extent at least, how much higher do tenure yields have to go? Have we seen, I guess, the bulk of the selloff there, or is there more to go on this re-steepening of the curve and pricing in higher inflation risk premiums and just risk premium in general? The charts, I'm not a chart guy, but the charts say I don't see any real support for US tens before. It's like mid-5.30s I think because it went straight down from there in 2007 and never came back. So what are your thoughts?

Joel Prussky:

I mean, as you well know, when anyone who's listened to my podcast with you in the past, I've never been a big-

Ben Reitzes:

I would call them rants.

Joel Prussky:

I've never been a bond bull. I think there's this equally chance for them to get to 6 as there is to 4 at the moment. That being said, I think we've probably overshot a bit, so I wouldn't be surprised to see some kind of push down maybe like a 30 to 50 basis point rally at some point over the next 2 to 3 months. It fishes every, sucks everybody in. And then I think it goes back to the supply and demand. There's too many bonds out there and there's a need for governments all over the world to fund themselves. And as long as that is true everywhere and they can't fix the budget deficit issues in the US. I mean when I start seeing that stuff changing, when I start seeing people saying we have overspent our... Look, we're starting to crowd out investment, our ability to do the energy transformation is going to be gone because we have entitlements that suck up all the budget.

So we are we going to raise taxes? I don't know. I mean the US I can't ever see that happening. Canada, I can, I'm sure we're well on our way to 60% marginal tax rates. So when I start seeing budget discipline, I think, it's easier to get constructive on bond yields. And until that point right here, I'm like, yeah, it'd be fine to own. I think if you bought some 10-year bonds and you own them for 10 years, you're going to be okay. If you own them for a year or two, you'll be okay. But, again, if 2% is the new 0, I don't know how 10-year yields can ever really go below 3% again, ever.

Ben Reitzes:

That's fair. That I believe. I guess, if we rally 30, 50 basis points in the next few months, I would be concerned, unless it's accompanied by seriously weaker US data. If it's not really bad data in the US that drives that no interest.

Joel Prussky:

Right. But I think to me that's the only catalyst. I mean, you have commodity maybe is coming off and stocks starting to teeter a bit and people are like, "They're going to lock in some of these yields." I mean, the pundits on TV have been telling the bond yields have been cheap or a bargain for 150 basis points now. And they've been throwing money to the TLT it's no tomorrow.

Ben Reitzes:

Oops. Yeah, okay. But I guess, that you need that US weakness to be a little more consistent for that rally to really last and then medium term, yeah, I'm with you. Rates are clearly higher for a longer period of time unless something changes in the supply/demand dynamic and

Joel Prussky:

I just think we're in a higher yield rate world. I think the last 15 years were abnormal, not normal. The problem is for the life of the average trader that is the last 15 years. And I think there's always, like I say, a recency bias in your brain going, "Well, we could get down there," so when the rally starts, no one cares for the first 30 basis points and they all pile in after 50. And then they realize, "No, wait a minute."

Ben Reitzes:

Oops.

Joel Prussky:

So I think there's a bit of that potential going on.

Ben Reitzes:

Okay, cool. Why don't we leave it there then since I don't know if you have any trade ideas today.

Joel Prussky:

I mean it's tough today. I think the good trade ideas today was a big day to correct a lot of them. The Canada versus US in the front end. The long end is a horse of a different color and not really my expertise. But the front end Canada was way too cheap. Those things moved like 10 to 12 to 14 or 16 basis points today. I do think receiving any meeting up near 20 is a gift here. It would have to be Jan, March, April kind of thing, because I kind of believe like you that we're just starting this slowdown and rollover. I could be totally wrong. This might be a soft patch and we could be-

Ben Reitzes:

A long soft patch.

Joel Prussky:

But maybe-

Ben Reitzes:

That would be like a nine-month soft patch.

Joel Prussky:

But we don't know. I mean, we just said that we didn't know about the data was revised down until it happened. So who knows? Maybe we're wrong. But I mean based on, again, it's a limited world myopic view. Toronto restaurants aren't busy anymore. House prices don't have 20 bidders they have 1 if they're lucky. So again, and that's just Toronto, and I don't speak for the whole country. But it does feel to me like things are slowing down because people have less money to spend. And whether that's because they're saving more as you say, or because their cost of living's gone up. And you know what? It was a hot girl summer, and everyone loved it, and it was great. And just like outside, it's cold and crummy. And that's the state of the bank accounts as well.

Ben Reitzes:

Winter is coming.

Joel Prussky:

Winter is coming.

Ben Reitzes:

For more than one perspective. All right, Joel, thank you very much for coming on today. And I will have you sooner rather than later.

Joel Prussky:

I hope I have more to say next time Ben, thanks for having me.

Ben Reitzes:

Thanks for listening to Views from the North, a Canadian rates and macro podcast. I hope you'll join me again for another episode.

Speaker 3:

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