Select Language

Search

Insights

No match found

Services

No match found

Industries

No match found

People

No match found

Insights

No match found

Services

No match found

People

No match found

Industries

No match found

Onward and Upward - Views from the North

FICC Podcasts December 16, 2021
FICC Podcasts December 16, 2021

 

This week, Adam Whitlam, part of the Toronto-based fixed income sales team, joins me to discuss the latest from the Bank of Canada and the outlook for 2022.

As always, all feedback welcome.



Follow us on Apple PodcastsGoogle Podcasts and Spotify or your preferred podcast provider.


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. 

Podcast Disclaimer

Read more

Ben Reitzes:

Welcome to Views From The North, a Canadian rates and macro podcast. This week, I'm joined by Adam Whitlam, part of the Toronto based fixed income sales team. This episode is titled onward and upward. I'm Ben Reitzes and welcome to Views From The North. In each episode, I will be joined by members of BMO's thick sales and trading desk to bring you perspectives on the Canadian rights market and the macro economy. We strive to keep this 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.reitzes@bmo.com. Your input is valued and greatly appreciated.

Speaker 2:

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

Ben Reitzes:

Adam, welcome back to the show. Good to have you on again.

Adam Whitlam:

Thank you very much, Ben. I'm honored to be your last guest of 2021.

Ben Reitzes:

Spoiler alert, this will be the last episode of the year. It is almost time for vacation for most of us. So for our last episode, I'd like to discuss the Bank of Canada latest meeting, and then we'll get to the outlook for 2022, but let's start with the bank. Last week's meeting came and went and that they weren't nearly as hawkish I think as everybody feared. They didn't drop the bomb that they could be raising rates in January. They kept their forward guidance. So effectively status quo really, and it's really the first time the bank has not out hawked themselves and we saw the market react accordingly and backed off from our most aggressive pricing. That has unwound a bit this week, but what are your thoughts on the bank here?

Adam Whitlam:

Well, I mean, it looks like the Bank of Canada likes a little bit of volatility in their market, because they seem to unwound some of what they said at the bank meeting last week today when they talked about forwarding guidance and the need to remove forward guidance being the next step toward raising rates. And when they discussed some of the changes with this whole dual mandate light, we'll call it, with the inflation band still in that sort of one to 3% area, but with a nod toward full employment. And I mean, Macklem made it very clear today that that applies when inflation is at their 2% target, but when you're running well north of that, which is where we are right now, as we saw in CPI today at 4.7%, that's unchanged from last month. That's no longer a factor and that they want to get inflation under control. So you're getting a lot of this seesaw action.

Ben Reitzes:

I think part of the back and forth in markets, I think the markets just got Monday wrong. I think when they came out with the inflation mandate, with the new inflation mandate, which really isn't new, everybody thought it was dovish. And in reality, it just isn't. We're not in those circumstances. Not only is inflation running at almost 5%, but the jobless rates are at 6%. There isn't a lot of slack in the labor market at this point, not enough to drive or keep policy rates at 25 basis points. So I mean, I think after listening to Macklem today, it seemed pretty clear that they do want to raising rates, not quite as soon as possible, but pretty darn close. The issue right now is Omicron. And we're seeing restrictions tightened throughout the country.

Ben Reitzes:

And that looks like it's going to be the trend for at least the next few weeks or so. And the holiday is probably going to be an issue as people get together and they're maybe a little bit less cautious generally as we've seen in past years. And so case counts almost certainly are going to rise over the next month or so probably. And that will impact the bank's decision in January. We'll see what the data do as well, but with Omicron trending the wrong way, I think January is a pretty tough sell for them to be moving on rates, but they could very well signal in January that they want to go in March if they drop their forward guidance. I think that's very much on the table if the data leaned the right way.

Adam Whitlam:

Yeah. I mean, to your point, I think even at the Bank of Canada meeting the week prior, I mean, they did make reference to the labor market that had improved quite significantly and that there wasn't that much slack in it. And so maybe when this dual mandate light came out Governor Macklem wanted to come out and enforce like, no, we told you, the labor market is in a much better place and we were clear at the October Bank of Canada meeting that we're going to do what's necessary to curb inflation, and this doesn't change that.

Ben Reitzes:

Exactly right. They're worried about inflation. Inflation has been the big topic for at least the second half of 2021. I think it's still going to be a big topic for at least the first half of 2022, maybe beyond there. So let's move to the outlook for next year. Just a few short weeks away. I guess my three biggest thoughts, and this is what I'm putting in the 2022 candidate strategy preview, the biggest themes are sticky inflation. And it's really tough to see inflation backing off materially in the near term. Inflation probably stays pretty elevated through at least the first half of the year and the risk are probably on the upside. Energy prices pulling back have helped a lot, but there's no guarantee they stay down here, and if Omicron is the last wave, then you could see some normalization again, put oil back at 80 or 90 bucks and that's going to drive another spike in energy prices and CPI would rise accordingly.

Ben Reitzes:

The second theme would be tighter monetary policy. And we already talked about the Bank of Canada. The Fed upped their dots today. Powell was not super hawkish by any means, but it's pretty clear that they want to keep their options open to raise rates more or less as soon as they can. That doesn't mean they're going to go in March or May, or necessarily immediately, but they want to at least have the option there. And we've already seen some other central banks around the world tightening policy.

Ben Reitzes:

And the third theme is that the recovery's going to continue. I mean there's going to be speed bumps and probably more so in Canada given the restrictions that are coming, but their households are in really good shape. The monetary policy is still stimulative, believe it or not. Just because they're pulling back on bond-buying or raising rates to 50 or 100 basis points, it's still just 1% guys and that's not a particularly punitive rate. So the economy's still going to likely be in good shape I think through the course of the year. Again, even if there are some speed bumps, I'm pretty positive on things still. Adam, what are your thoughts on next year?

Adam Whitlam:

Yeah, I mean, I tend to agree with you. Sticky inflation is going to remain and I think we're going to continue to see demand for goods drive inflation higher. We've seen things that are stickier like wage inflation come into the market as well and higher rents and that stuff doesn't tend to go away very fast. So I think, in the beginning quarter of 2022, we were looking for maybe some year over year comparisons, which might push inflation down, but it looks like at this point, I think the risk is that those won't be pushed down, if anything, they'll be stronger than expected. And that will just exacerbate rate hike fever and put pressure to the Bank of Canada to normalize rates sooner than expected. We were talking about this earlier in the week that the Bank of Canada, the tendency from them over the last decade or so, well, I guess it'd be longer than a decade, probably 20 years, is that when they start a rate hike cycle, they typically like to hike rates consecutively after that.

Adam Whitlam:

So, we're paving the way for something like a 25 bp hike in March follow by a 25 bp hike in April and possibly another one after that. So I think we'll get a scenario where you will see these consecutive rate hikes early on in the year in Canada, followed by a pause, see how it gets absorbed, see what the impact is to the economy. See what the impact is on the housing market, which we're still very vulnerable. I mean, indebtedness in this country is still touching record highs or close to record highs. So that's still going to be something they're watching really closely. But yeah, inflation, I think is going to persist. And as a result, we're going to see higher rates in the front end in the very near future.

Ben Reitzes:

So what trades are you looking at? Any products or anything at all that grabs your attention as a trade for 2022?

Adam Whitlam:

Yeah, I've had a look at a couple of like the meeting gap flies, looking at things like March, April, June. Given what I was saying about the propensity for the Bank to hike at consecutive meetings and how that's kind of existed in the last little a while. You can put on trades where you can receive April versus pay the wings. And we're talking about one and a half to one and three quarter basis points differentials on that stuff, which is quite skinny when you see a 25 bp hike at each one of those meetings. So I think the risk-reward their favors putting on some of these flies. I still like some of the pricing in the front end. We don't have nearly as much. I think the last time I was on here, we were pricing five and a half and six times into the front year followed by maybe another one and a half hikes for the following year.

Adam Whitlam:

We've eased off that given the rally that we saw on the front end, after the most recent Bank of Canada meeting, but there are still attractive trades, like one year versus five year, one year versus 10 year. I mean one year versus five year around last I looked, it was like negative 12 bps and that got to negative 20, but that's about the lowest it has ever been. So if you do think that the Bank of Canada is going to hike rates a few times and then pause, then some of these forward gap trades take advantage of a more prolonged period of rate hikes as we absorb what happens. But I mean, there are also just ways of saying if inflation's going to continue to run hot next year, then things like five-year bonds and 10-year bonds look very expensive in Canada.

Adam Whitlam:

And that curve looks very, very flat. Now, what I go as far as to say, the tens, thirties looks too flat, that's a whole different animal. There's a technical picture behind thirties. One of the reasons we've seen 30 years run up so much into this time of year is we have a lot of extensions that have gone on in Canada. The market I think was less prepared for the extension that went on this time around. So I think it was a little more exacerbated, but tens on the curve, whether that's fives, tens, thirties or one year, one year, 10 year and 30 year, or however you want to structure it, that part of the curve looks too rich if we think inflation's going to be sticky.

Ben Reitzes:

Fair points. I generally agree, and we'll be writing most of that in the preview for 2022. What are your thoughts on the curve for 2022? And I'll go through four different things and then you can tell me your opinion on that. Flat or steeper? Why don't we make it simple, flatter or steeper?

Adam Whitlam:

It depends on what part of the curve we're talking about.

Ben Reitzes:

Big curve, five thirties.

Adam Whitlam:

Big curve. Okay. So fives thirties, I think fives thirties, you're going to actually see continued flattening. I think a lot of the pressure fives have been the pivot point for more hawkishness from our central bank. And I think you're going to continue to see that trend. The US curve five thirties have been continuing to flatten. I think the recent low we got there was probably 51 bps and we're probably at least 10 bps away from that and I would expect that breaks through in the new year, and I think Canada's going to follow suit.

Adam Whitlam:

Our long end has retained structural bid for it. There's also been a bunch of changes going on from an accounting endpoint. There's been a lot of talk about IFRS 17 and what that's going to mean for some of the insurance companies and the impact that could have in the long end, which depends on who you ask, but I think there's a natural bid for some longer duration there as a result and I think that's going to be supportive of five thirties flattening and I think you're going to see more pressure on fives going through the year.

Ben Reitzes:

Flatter. That's the answer. I agree. Tough to fight the trend, especially if rates are rising. Maybe once if the bank pauses after a few hikes, then maybe you get some bouts of steepening, but the bigger trend is still there. Canada and US prices.

Adam Whitlam:

So in the beginning of the year, I got to say, Canada is going to underperform the US. I think we've come a long way. It also depends a little bit on the part of the curve that you're looking at.

Ben Reitzes:

Why don't we go with the long end?

Adam Whitlam:

Yeah, I think Canada is going to underperform, but that's more just because looking at the massive performance we've had over the last month and the amount of supply that we have coming in the first quarter of 2022, I mean the provincial issuers have 32 billion of financing to do by the end of March, which although it is a big number, I would probably point out that in January 2021, they raised 20 billion in that month alone. So the market can absorb it. Now, that being said, when you have all in rates at these lower levels, it does sort of push out some of the marginal buyers.

Adam Whitlam:

So I think you're probably going to see some give back from the big performance we've seen in Canada, US, in thirties. In the 10 year part of the curve, it's a little bit trickier. I mean, I think tens look very expensive in Canada. I think I'm going to go with underperformed as well. I think tens in Canada look rich on our curve. I think that's probably going to underperform and that's consistent with what I think is going to happen in the fives and thirties. So I think we'll underperform in both sectors.

Ben Reitzes:

Okay. And one thing, my only rhetoric would be on the provincial side. A lot of that issuance's probably at least half, if not, even more, will be international. So that means the Canadian market doesn't need to absorb that much, but it is still about a billion a week, which isn't nothing by any means. So that's definitely fun to keep in mind. And on the Canada and US theme, I mean, I'd highlight the five year sector in that the market is still pricing a terminal rate in Canada of around 2% and only one 50 in the US, and that just doesn't seem right to me. And I think as the year drives on and we see rate hikes from the Fed and the market is able to absorb them and the economy is able to absorb them well, I think that probably moves and Canada cannot perform there a little bit. Last, but not least, provincial and CMB spreads.

Adam Whitlam:

Well, we've had a pretty good year for risk assets. Risk assets have remained bid even in the face today where the Fed was a little more hawkish and raised the dot plots. You're still seeing a day where equities are up 300 points last time I looked in the Dow. And so the risk has had a pretty good move and spreads have moved quite a bit tighter. IG spreads have moved tighter, high yield spreads are backed off versus IG from the tightest levels that they were at, but we're still historically pretty rich. So I would expect spreads to widen, or I think there's not much room for spreads to really grind in and considerably tighter from here. I just don't think there's as much room to run.

Adam Whitlam:

And I think again, all of the yields are probably going to prevent some of the marginal buyers from stepping into that product. And if they do need to reach for yield, and if we do retain a pretty positive footing to the market or solid bid to spreads that they'll have to reach further out to credit spectrum than say something in the provincial market. So in that regard, I think there is room for provincial spreads to widen a little bit from here. Maybe if we get yield selling off a lot, that could reverse course, but from here at net, I would say that they could be in for a little bit of widening.

Ben Reitzes:

Yeah. I think they're definitely going to struggle. Just given the levels where we are and if central banks are pulling back. That's generally not a good thing for risk assets. So they could struggle here, at least for a bit. But if rates do go back up, I think that would be a very big support. Then you see buyers come in. When you get 30 year probes back up to 3% or so. We do some buyers tend to come in and lift at that level.

Adam Whitlam:

So Ben, given it's the end of the 2021 podcast, and we're looking at forecasts or what we think for 2022, what do you think about putting some levels on where we think things are going to be in the middle 2022?

Ben Reitzes:

Okay. Let's do it. We'll make it interesting. Why don't we wager a bottle of wine?

Adam Whitlam:

Well, that sounds good. I've got my finest Jackson Triggs for you.

Ben Reitzes:

Maybe I'll let you keep that one. So what levels are we looking at?

Adam Whitlam:

So why don't we throw something out there with fives, tens curve, and we're looking at June 1st, 2022. Fives, tens curve, 10 year, absolute Canada yields, and 30 year provincial spreads Ontario.

Ben Reitzes:

So five tens right now are trading around 14 basis points between 14 to 15 basis points. It's hard to believe that we're going to flatten materially, but I mean, that's been the trend. I don't know when that's going to stop. And if the bank Canada is indeed raising rates and doing so probably in back to back or maybe three in a row, that'll still be happening in June. So I think flatter than where we are now.

Ben Reitzes:

I go with the sub-10, somewhere between five and 10 basis points. So not hugely flatter, but there really isn't that much more to go. And I mean none zero probability of inversion, but I think that's kind of a long shot because rates I just don't think they'll be punitive enough to weaken the economy sufficiently to drive that kind of response. 10 year rates. Why don't you give them a level on 10 year rates?

Adam Whitlam:

Great. So, I mean, my forecast across the board is that rates are going to be higher from here than lower. I mean, that's not really the boldest call out there given the move that we've had in the curve, but with 10 year rates just below 150, I'm going to say that you're going to see Canadian tens in that 175, 180 contexts.

Ben Reitzes:

Okay. I would take the overrun, but that's me. So on provincial spreads, the last one, I think a little bit wider from herein the low 80s, call it like 82, 83, somewhere in that neighborhood. I think that's probably where we'll end up at that point. And so we'll see who gets these, right?

Adam Whitlam:

I was going to take slightly wider than you, but I'm kind of in the same ballpark, I was going to get into that sort of 86 level where we start to see some pretty good support, but I don't think we're going much wider than that.

Ben Reitzes:

So we agree on that one. So it's going to be the curve and the outright rate where this wine bit gets done.

Adam Whitlam:

Yep.

Ben Reitzes:

On that note, I think we can wrap things up for 2021. Adam, thanks again for joining me.

Adam Whitlam:

Thank you again for having me. This is a joy every single time.

Ben Reitzes:

And it's a joy having you. So this is the final episode of Views From The North for 2021. I'd like to thank everyone for taking the time to listen to my podcast this year and I hope that you'll tune in to 2022 as well. Finally, happy holidays and happy new year to all. And I look forward to seeing and speaking to many of you next year. 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 2:

This podcast has been repaired with the assistance of employees, of the Bank of Montreal, BOM's incorporated. And BMO capital markets' corporation. Together, BMO are involved in fixed income in 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.

Speaker 2:

Notwithstanding the foregoing, this podcast should not be construed as an offer or the solicitation of an offer to sell, or to buy, or to subscribe for any particular product or services, including without limitation, any commodities, securities, or other financial instruments. We are not soliciting any specific action based on this podcast. It is for the general information of our clients. It does not constitute a recommendation or a suggestion that any investment or strategy referenced here in may be suitable for you.

Speaker 2:

It does not take into account the particular investment objectives, financial conditions, or needs of individual clients. Nothing in this Podcast constitutes investment, legal, accounting, or tax advice or representation that any investment or strategy is suitable or appropriate to your unique circumstances, or otherwise, it constitutes an opinion or a recommendation to you. 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.

Speaker 2:

BMO is not undertaking to act as a swab advisor to you, or in your best interest to you to the extent applicable. You'll rely solely on advice from your qualified independent representative in making hedging or trading decisions. This podcast does not be relied upon in substitution for the exercise of independent judgment.

Speaker 2:

You should conduct your own independent analysis of the matters referred to herein together with your qualified independent representative if applicable. BMO assumes no responsibility for the verification of the information in this podcast. No representation or warranty is made as to the accuracy or completeness of such information. And BMO accepts no liability whatsoever for any loss arising from any use of or reliance on this podcast. BMO assumes no obligation to correct or update this podcast. This podcast does not contain all information that may be required to evaluate any true transaction or matter, and information may be available to BMO and/or its affiliates that is not reflected herein.

Speaker 2:

BMO and its affiliates may have positions long or shorts and effect transactions or make markets in securities mentioned herein or provided advice or loans to or participate in the underwriting or restructuring of the obligations of issuers and companies mentioned herein. Moreover, BMO trading desks may have acted on the basis of the information in this podcast. For further information, please go to bmocm.com/macrohorizons/legal.

 

Benjamin Reitzes Managing Director, Canadian Rates & Macro Strategist

You might also be interested in