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The Notorious B-E-A-R - Views from the North

FICC Podcasts April 29, 2021
FICC Podcasts April 29, 2021

 

This week, Joel Prussky, BMO's OIS and cross currency trader joins me to share his insights on the recent Bank of Canada policy announcement, Federal Budget, how inflation is set to accelerate and his favourite trade ideas.

As always, all feedback welcome.


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About Views from the North

BMO’s Canadian Rates Strategist, Ben Reitzes hosts roundtable discussions offering perspectives from strategy, sales and trading on the Canadian rates market and the macroeconomy. 

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Ben Reitzes:

Welcome to Views from the North, a Canadian rates and macro podcast. This week, I'm joined by BMO's OIS and cross-currency trader, Joel Prussky. This week's episode is titled The Notorious B-E-A-R.

Ben Reitzes:

I'm Ben Reitzes, and welcome to Views from the North. Each episode, I will be joined by members of BMO's FICC sales and trading desk 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.

Speaker 3:

The views expressed here are those of the participants and not those of BMO Capital Markets, its affiliates or subsidiaries.

Ben Reitzes:

I'd like to welcome Joel back to the show. He's a regular guest now and I always enjoy talking to him.

Joel Prussky:

Not unlike my marriages, Ben. Third time's the charm.

Ben Reitzes:

Third time is the charm. I think this will be our best episode. There's lots of talk about. So the last few weeks have been pretty eventful in Canada. We got the Bank of Canada last week. They came through with a taper as expected and sounded materially more upbeat. We also got the federal budget which had piles of spending on it, also pretty much as expected. There were some interesting parts of the budget though on the issue in front, we can get to that, but I'd like to ask you first about the Bank of Canada. Governor Macklem was particularly upbeat, I think, probably more than what most people thought given we're still going through the third wave here. What are your thoughts on that, Joel?

Joel Prussky:

I think it was an acknowledgement that things are better than they expected and we managed to find new ways to consume and do business a lot better than their worst case scenarios. Not really unlike what Powell just said a few scant minutes ago. The difference I think is how the market has acted or reacted between the two countries.

Ben Reitzes:

It seems like the market believes the Fed a lot more than they believe the bank although, at this point, the bank has pretty much come to where the market is. The market had been pricing a much more aggressive Bank of Canada than what the bank had been putting out there. And as the data improved, I think they moved more toward where the market was. The market clearly had a bit more foresight there than the bank did. Whereas for the Fed, really until very recently, rate expectations have been pretty far out on a relative basis. Not quite as far as the Fed's dots, but further out than Canada. I guess that's probably a function of their tolerance for inflation. Is there anything else in there maybe?

Joel Prussky:

I think there's a couple of things. I think for one, because Canada is much less liquid than the US, when you do get reactions in the market, they tend to be overreactions because of liquidity. That's one reason. If you're talking about why we put a pin in when the banks can hike and how much more aggressive they're going to be, I think a lot of that's just a function of the lack of liquidity in Canada. But I also think that in terms of the Fed, the market believes what they want to believe.

Joel Prussky:

Powell has promised not to hike until a certain timeframe. That's the market's interpretation only. He's promised to keep accommodation in the market. They don't define what that is. I just listened to his rather boring press conference and I would say he didn't tell you anything. And I really believe that, just like Canada, the market will eventually be way ahead of the Fed. The Fed's never been proactive in the 33 years I've traded. Let's be honest about one thing.

Ben Reitzes:

So you're expecting, effectively, the market to price a more aggressive Fed at the end of the day. In your first appearance with me, you were particularly bearish on rates. Sounds like that view hasn't moved one iota.

Joel Prussky:

It's hard to get excited about owning fixed-income securities. Think about the US, they are ready to adopt a flexible average inflation targeting. I think the Bank of Canada is as well, whether they call it that or not, but we're all willing to tolerate overshoots of inflation. So we have very negative real yields. I just don't see the value in owning, let's say, 10 year Canada bonds at 1.50% when we know we're going to see inflation out close to, I think, well above 2% for the next several years. It just doesn't make sense. It seems all risk, no reward.

Ben Reitzes:

I'm very much with you there. For me, I think the risks on inflation are still one-sided. They're on the high side. I understand the secular arguments against inflation and where we've been and where things have been for the past, I don't know, decade plus, but we're not there. We've never had this kind of stimulus in place before fiscally and for monetary policy authorities at the same time.

Ben Reitzes:

There's potentially significant inflation coming in, and you're starting to see dribs and drabs, but I think we'll probably get a better picture toward the end of this year when things are fully reopened. So the question then is how persistent is that inflation? At that point, I'm not entirely convinced it will be permanent inflation per se, but it could last three, four, five quarters. And if it does, is the market prepared to look through three, four, five quarters of inflation? I suspect not. That would mean probably a notably steeper yield curve than where we are today.

Joel Prussky:

And higher in general. Remember he mentioned today, several times, our inflation expectations. And the real risk is that inflation expectations stay high. Right now, the Fed says that we'll look through it. We could even go up to 2.6% because we've undershot on our fake inflation measure for the last 10 years. And we're willing to overlook it as it goes through it. But if it starts to get ingrained into people and what they expect, then the Fed has a different problem. It's something that they've not ever done in 20 years, which is basically have to spank the market.

Ben Reitzes:

Well, we shall see on the inflation front. I think the only issue there is there's a long way to go before we get there. I think in the near term, everyone's going to think it's transitory, and it probably will be. And we're still not going to reopen fully in any way, shape or form till later this year. And then we'll see where the inflation numbers sit by then. Still ways to go there.

Joel Prussky:

I agree with that. But the problem is when those inflation numbers come out, everyone can say," Well, we're willing to look through them," except still that print at 2.4% or 2.5% doesn't make you really super bullish. It's one thing if the market was to sell off 50 or 75 basis points to a level where I think guys would say," Well, wait a minute. If we got up to here, I'm comfortable on the risk/reward." I'm just not so sure at current levels that risk/reward favors owning fixed-income securities.

Ben Reitzes:

That's fair. I would just say that the higher prints that are coming, they won't even matter. We won't react at all. The prints that will matter for the market will come much later this year, probably more in the fourth quarter, maybe even early next year, depending on how the vaccination schedule ramps up or down or how variants work out and how the pandemic evolves over the next year or through the rest of this year, call it. One point I think that maybe I didn't stress enough in my analysis of the bank was their seeming acceptance of Canadian dollar strength. They just didn't seem to be overly concerned about the strength of the Canadian dollar.

Ben Reitzes:

And it's continued to move since then. And whether that's because of the bank or not, I'm not even sure it's relevant. It's more like is the bank under this governor more willing to see a strong Canadian dollar? If you get through the Poloz years, that was clearly a focal point. Under Carney, didn't seem like the bank cared all that much when the currency was strong. Are we back to those Carney years where Macklem was the senior deputy governor for much of that time? Or is it more like Poloz? Are we in between? Is something coming on that front? Do you have any thoughts on that?

Joel Prussky:

I think Tiff is a bright guy. He's been an insider for his entire career. He knew by coming out and saying what he said, that would be a green light to strengthen the Canadian dollar. And I think it's a good kind of strength at the moment in terms of trade, commodities. I get that. So I think at the moment it doesn't bother him, but that's not to say at 1.18, he may feel the same way.

Ben Reitzes:

That's fair. I think that's probably the right way to look at it. I just think that by not saying much of anything about the currency, they've given markets a green light to test how far they're willing to accept it. And so you wouldn't be shocked if you were to get a little more persistent Canadian dollar strength in the near term, which in turn is a dampener on growth and inflation and all that here.

Joel Prussky:

Everything is the same trade remember. I think there's a reflation narrative going on globally. It's value over growth. It's commodities, it's Canadian dollar. Everyone is in different forms of the trade macro-wise and the Canadian dollar is just a form of that macro trade.

Ben Reitzes:

It's true. As we reopen, commodities will probably continue to stay relatively well bid, which is obviously a positive for Canada. Oils calmed down a bit here, but everything else is gone. Lumber's gone bananas and then wheat prices have gone up a ton. And you're just seeing commodities bid almost across the board here, which obviously is a positive for the Canadian economy which is a big commodity exporter and producer. You've been in the business a long time. I'm not going to dare you, but it's been a while. You're bearish on duration now. And I'm curious about what you think about the issuance profile that the government of Canada came out with last week.

Ben Reitzes:

So for those who don't pay that much attention to Canada, Canada has increased the weighted average maturity, or is going to increase the weighted average maturity of issuance significantly again this year. Issuance of tens and longs. Longs is flat, tens are up another $10 billion despite a near a hundred billion drop in total issuance. So if you go back over the past few years, so in fiscal year 2019/20, 10 year and longer issuance was 14% of the total and total issuance was 124 billion. In fiscal year, 2020/2021 we went up to 29% and that's of 374 billion. And this coming year that started April 1st, it's going up to 42% of 286 billion. And so the dollar amounts keep going higher here, significantly so. Now it has to play toward your hatred of duration.

Joel Prussky:

Part of the promise, I think the bank muddled the message on that, did they not? I know we love to drop bombs on Fridays at four o'clock in terms of things that the Bank of Canada does, but I wouldn't be surprised if they did make some changes in terms of the profile.

Ben Reitzes:

You mean QE though. On the issuance side, the government is issuing massive amounts of new long bonds and 10 years. On the QE front, I think you're right. It sounds... And if you listen to the bank speak, if you listen to Macklem in front of parliament or the Senate committee, he really stressed the political independence of the bank from the government. It seems clear to me, at least, that they didn't want to just mimic the changes exactly to the issuance profile to divorce themselves a bit from making it seem as if they're funding the government. That's kind of a separate conversation, if they're funding the government or not.

Joel Prussky:

How could that be a conversation? It's not a conversation. Are they funding the deficit? Yes. Next topic.

Ben Reitzes:

I will sympathize with you. So I actually take a bit of a more nuanced view. I think the nuance comes in if they were to hold those bonds and let them mature and not reinvest, I can sympathize with them saying this is temporary. But when they make absolutely clear, which they have, their intent to reinvest maturities with no necessarily fixed end date on that, that to me is like open-ended financing. That means you've permanently financed it. So unless they let their portfolio run off, which is going to be awful challenging given the maturities that do come up starting in 2022, that's where I draw the line personally.

Joel Prussky:

Well, and this goes back to a supply demand equation. For years Canada's curve was what I thought was ridiculously too flat because there just simply wasn't enough long bonds out there for the people who wanted to buy them. And swap spreads always stayed high and things got silly and the bank had an option to extend WAM way back then when long bonds were sub 1%, and they didn't. I get it, whatever. That's their choice. That's why they're not in the private sector I'm guessing.

Joel Prussky:

But nonetheless, now we have the opposite problem and there's going to be too many bonds and it's another reason to be bearish the way I see it. We need to get yields to a level to entice people to buy our bonds. That's a challenge I think America's going to have as well which is why extricating themselves from this mass is going to be a huge challenge for both the Fed and the bank, because how do you reset the supply demand equation given the massive amounts of supply that's coming?

Ben Reitzes:

One of my favorite parts about Canada is that it is a very difficult market to predict. There was a knee-jerk reaction on the back of the increased issuance in tens and longs. And you got some weakness there and some steepening and cross-market weakness. Since then, and over the past week plus, really the past week or so, Canada has consistently outperformed. Any explanation on that? Maybe just everyone's had enough. The last longs in Canada have gotten washed out and now the market is free to rally from here. It's caused the most amount of pain.

Joel Prussky:

I think that's very true. We went into the Bank of Canada, again, much more hawkish. We were the first to hike. We were the most to hike. I picked June 2023 BEDS, which is back, versus your dollars. They were up at 68 basis points. And then Bank of Canada came out, everyone's like," Get out of Canada." It was hawkish. We were already really pricing in a pretty aggressive and soon-to-go bank. That pushed out to 75. I think two-year one-year got into the mid-sixties. And then of course it's the three day rule I'd like to think. It's like fish and in-laws. After three days, they get bad. And three days after the Bank of Canada meeting then all of a sudden Canada started turning around because it washed out the bad longs, of which I was one of them.

Joel Prussky:

And also because people said," I get it. He's right to be hawkish, but relative valuations do matter." And BED spreads at 75 basis points essentially means two and a half hikes by the Bank of Canada before the Fed. Historically, that's pretty unusual. And Canada is a canary in the coal mine of global rates. And I think it's really important for other domestic places, whether it's UK or US, for example, or Aussie, to see how fast that sentiment can turn and how quickly that part of the curve can get pounded. That one-year one-year and two-year one-year, what we call reds and greens future space, because we acknowledged stronger growth and we got killed. Well, growth is even stronger in the US and they're reopening way faster than we are.

Joel Prussky:

So at some point, regardless of what Jay Powell said today, a series of numbers is going to come out that people are going to say," Oh my God." He can say he's on hold and he can say this, that, and the other thing, but this strength is overwhelming and you could see a payroll number at 1.5 million next week. I do believe that, and the market's going to say," But Daddy Jay said he's not going to raise rates ever." Well, you know what? That's crap, I'm sorry. He didn't say he's never going to raise rates ever. He said he's going to keep things accommodated. There's a huge difference there. And I think at some point the market says," Wait a minute. 1% rates in three years’ time, that seems pretty low compared to history."

Ben Reitzes:

I'm with you there. Next week will be interesting because you may get that one and a half million print like you mentioned, and Canada might be negative 200, 300, 400,000. Do you think that moves things at all? Or were just fully expected there and fundamentals still are, to some extent, taken back. So really, it's just temporary for Canada and who cares?

Joel Prussky:

Yeah. Look, a print, I think you have to look at it in the context of the rate differentials, not overall. If the US has plus 1.5 and Canada's down 500 even, let's just say. Canada, US relative rates will narrow. Absolutely. But rates will be significantly higher in the US and Canada will follow, and we are still managing to look through. As horrible as things are, especially in Ontario where obviously we're from and have the most inside knowledge of, we are making progress. We are starting to vaccinate lots of people.

Joel Prussky:

Once we get through this latest surge and start getting a lot more jabs into people's arms, things will be better come June. It doesn't take much science to make you realize that and you have to be forward-thinking. So I think it means something on interest rate differentials between Canada and US, but I don't think it means a lot. In Canada, rates can't move materially lower just because we're down 400 and the US is up 1.5 because you have to look through that.

Ben Reitzes:

That's cool. Anywhere on the curve where you're most focused there, Canada or the US?

Joel Prussky:

I'm a simple guy, so I pick the highest place. So if you're in the future space, it's June three. If you like swap space... Hold on. I'm just hitting update as we speak because I have a little reveal time sheet that tells me what's what, and it was two-year one-year is up at 65 basis points. I think that's the sweet spot. 2y2y was up in the mid-sixties as well. It's come back a bit. But I also like your idea from earlier in the week Ben, the 2s5s box trade. Swaps, not bonds because I think bonds get too technical and it's just not worth it because you could wind up being short or long a bond that all of a sudden you find the Fed owns 97% of them and you can't get what you want or the Bank of Canada owns too many. So I would always do it on swaps because let's face it, swaps are where it's at.

Ben Reitzes:

Says the swap trainer. So I just don't see how that can steep in materially from twos fives. There's probably maybe 10 or 15 basis points' possible steepening, but given the bank's turn here, it's certainly possible that the steeps are already in on that curve. And so, whereas the Fed still needs to make their more hockey's turn and if anything, were probably a little bit underpriced there for the US. So it does seem as if there's room for Canada to flatten a little bit relative to the US.

Joel Prussky:

It's all variations of a theme. Because if I look at my 2y2y, for example, historically, where do you think rates are in Canada relative to the US? And I don't mean going back 30 or 40 years but let's say over the next last 10 to 15. Generally speaking, 50 bps a differential is about the max we could go in either direction. So if you're up and look at something that's got two-year one-year in swaps at 65 or BEDS at 73, you're talking about pretty much the max, except for the rare cases where the Fed was super aggressive and had to cut rates like crazy, only of which then Canada followed shortly thereafter. But we both had these massive indebted economies now. We've solved each and every crisis with more and more debt. So I just don't think we're in a place where we're going to see Canada's ability to raise rates independent of the US much more than 50 basis points.

Ben Reitzes:

All good points. That 50 basis point level is where I put the maximum differential personally. I just think the dollar starts to move too much after that and then you get more expectations baked in. You get back to, again, 2011, 2012, and that point Bank of Canada raised rates and the Fed was not there yet and eventually eased further. And you had that two-year two-year up at a hundred basis points. I think that's probably a bit of the fear that the market might have, but we're not in that place. There was no financial crisis. The US is better off, not worse off in this case. There's no reason to believe that that differential is going to get anything past... Even 50 bps is probably on the extreme side.

Joel Prussky:

The only way I think you could even get there is if you're talking about taking rates back to let's say 3 or 4%. Because then the fifties are less relevant as a percentage. 50 basis points at 1% overnight rates is a huge difference. But if you believe that there's a chance you can get rates to three or 4%, it gets us back to the title of this podcast. And what are you doing by [March 00:20:44] your dollars at 98.80? Give me a break. Those things are 200 basis points rich.

Ben Reitzes:

It would be something to get back to three or 4%. As you mentioned the debt burdens are substantial to put it kindly. And so that on its own suggest that rates probably can't move all that much, unless you get a burst of inflation and you would flight away some of that debt. I think that's probably the only way to get there. I wouldn't rule that out. I'm not even sure that governments would mind all that much. Their spending's a bit more affordable, to use kind words. There is still plenty of spending coming, not just in Canada but in the US as well.

Joel Prussky:

So what's our star? Honestly, after three years, I can't tell. Looking at the market, if someone sells a five-year seven-year, I'm like," Forget it." Three years is the most I'd look out and we have our star at 1%. I just think that's low.

Ben Reitzes:

That's too low. I picked the peak of the last cycle, 1.75. Somewhere in that neighborhood, I think, is a reasonable place to think about our star on a nominal basis. On a real basis, it would probably be around zero.

Joel Prussky:

One of the things I have a problem with is that we're looking through what we just went on through an 08 lens. And that's not really right. There's massive fiscal, which we never had. And it's not all eight. The financial system isn't in peril. It's so different. So when people say," Well, based on last cycle, the Fed is going to stay at zero bound for so many years." I'm like," These are apples and oranges." It's not even the same.

Ben Reitzes:

I think what you want to do, though, what I'm saying is the end of the past cycle, just like pre-pandemic, when you had jobless rates at multi-decade lows. That is somewhat indicative, I think, of where we can get to from a rate perspective. There was other stuff going on and we didn't have this kind of fiscal impulse, and we didn't have the type of household savings.

Ben Reitzes:

And I think there's way more upside potentially, but the massive debt burdens that are just hanging over us like an anvil or a cloud, depending on how you want to look at it, are limiting factors. And I just don't see how you can move rates that much higher without crushing the government for one. In Canada's case, hitting households pretty hard given high debt to income ratios that haven't gone away. We don't talk about them anymore because there's other stuff to talk about, but they're still there. Joel, any trades you like, favorite trades before we call it a day?

Joel Prussky:

I've been beaten up on the trade, but I do like the Canada-US. I like receiving Canada, paying US. I think, like I say, if you're a futures trader, June three BEDs are the best. I think if you are swaps the two-year one-year space makes a lot of sense. I think in OIS, there's nothing interesting to do. In cross-currency space we have a fairly steep curve. There's a lot of really interesting trades to do out there, but I suspect most of your audience doesn't really play in there. So we'll save that for a personal one-on-one call. If anyone does care, please reach out to me. But otherwise, no, I don't see a lot of great stuff at the moment.

Joel Prussky:

I think liquidity has really been shattered over the last while. And I think also the next generation of traders isn't providing liquidity the way it used to. So I think it's a lot harder to get yourself into trades because you have to give yourself more breathing room because the liquid nature of the market means dumb things tend to get really dumb. So when it pops up on your screen and you go," This seems cheap," wait it a week or two with five basis points, and then you'll be," This seems dumb." And then stick a toe in. And then two weeks after that when it's as dumb can be, then you say," Okay, now I'm all in."

Ben Reitzes:

I think that's represented a fair caricature of the market at this point. It has been challenging for the past while, and with the Bank of Canada eating a lot of liquidity in the market, I think it does make it also challenging on the cash side in particular. Myself, I like fives on the curve right now, as we mentioned. That just looks like a reasonable place to hide at this point. If you look at the twos, fives, tens, fives look as though they have some room to go. And cross market, I think is a lot more challenging. It's super tempting to still like Canada and fundamentally I still do, but fundamentals haven't really necessarily mattered on that trade all that much. So maybe they'll matter from now on, but I guess we'll see on that front. Joel, thanks again for joining me. Appreciate your time.

Joel Prussky:

And thanks for having me. I hope to look forward to seeing you on the golf course soon.

Ben Reitzes:

That would be truly wonderful.

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:

This podcast has been repaired with the assistance of employees of Bank of Montreal, BMO Nesbitt Burns Incorporated, and BMO Capital Markets Corporation. Together, BMO, who are involved in fixed income and foreign exchange sales and marketing efforts. Accordingly, it should be considered to be a product of the fixed income and foreign exchange businesses generally, and not a research report that reflects the views of disinterested research analysts. Notwithstanding the foregoing, this podcast should not be construed as an offer or the solicitation of an offer to sell or to buy or subscribe for any particular product or services, including without limitation, any commodities, securities, or other financial instruments.

Speaker 3:

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Speaker 3:

BMO is not providing advice regarding the value or advisability of trading in commodity interests, including futures contracts and commodity options, or any other activity which would cause BMO or any of its affiliates to be considered a commodity trading advisor under the US Commodity Exchange Act. BMO is not undertaking to act as a swap advisor to you, or in your best interest in you, to the extent applicable. We'll rely solely on advice from your qualified, independent representative making hedging or trading decisions. This podcast is not to be relied upon in substitution for the exercise of independent judgment.

Speaker 3:

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Speaker 3:

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Benjamin Reitzes Director, Canadian Rates & Macro Strategist

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