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Thank You Sir, May I Have More Stimulus? - Views from the North

FICC Podcasts April 15, 2021
FICC Podcasts April 15, 2021

 

This week, Fred Nastos, co-head of core FICC trading, joins me for his third appearance on the show. We discuss next week’s Federal Budget and Bank of Canada policy announcement.



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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 Fred Nastos, co-head of core FICC trading. This week's episode is titled, "Thank you, sir. May I have more stimulus?" 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 dot 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, not those at BMO capital markets, its affiliates, or its subsidiaries.

Ben Reitzes:

Thanks for joining me today, Fred, even though you're on your week off. Fortunately talking macro and rates with me is one of your favorite things to do so I'm sure you have a big smile on your face right now.

Fred Nastos:

Thanks for having me on again. So I guess next week we have two important events in Canada with the federal budget on the 19th and the Bank of Canada on the 21st, so I was hoping to slightly turn the tables on you and get your view on what you expect from the budget before talking about the BOC.

Ben Reitzes:

Sure thing, that sounds like a great idea. I love being peppered with questions, and that is my job after all.

Fred Nastos:

That's great to hear, Ben. So what do you think the big takeaways, or what are you going to be looking for in the budget next week?

Ben Reitzes:

I think there's a few things that we'll be looking out for. The appetite of the government to spend given the current macro backdrop is probably the biggest question mark. In their fall economic statement they laid out after it what's expected to be a massive deficit for this past fiscal year, just over $380 billion. They also put forward that they're going to spend between 70 and 100 billion in stimulus over the next three years. That money was unallocated. It was just kind of general stimulus on whatever tickles their fancy.

Ben Reitzes:

At this point, though, the pace of the recovery has been far better than pretty much anybody expected, and the economy is going to grow at a much better than expected pace for 2021. There's a pretty big question as to whether that 70 to 100 billion over three years is even necessary, and if it is, maybe not that size. So perhaps I guess I ask questions is how small do they start for this year? Are they still committed to that 70 to 100? Or maybe those numbers come down a little bit. Beyond that I think there's a number of different policy aspects we can discuss if you'd like.

Fred Nastos:

To me that 70 billion, it really comes down to how it gets spent. Is it wise, timely investments, infrastructure, or do they have a worst payoff structure?

Ben Reitzes:

To put it kindly. So what they did say at the time was that they don't want to create any permanent spending. I mean, sticking to that commitment though has tended to be pretty tough and they already have pretty much leaked that they're to do something on childcare, which sounds pretty permanent to me. So it's tough to say. I would love to see more infrastructure spending given the poor state of infrastructure where we live in Toronto, but we'll see. And it's been notoriously difficult to get that money out the door also in infrastructure. And if you recall, when the Liberal government first came in in 2015, that was their platform and it took years for them to really push that stimulus spending out at the time. So I'm not sure why this time would be any different than then, but I guess we'll see.

Fred Nastos:

So the childcare aspect is interesting and clearly really important. Would that supplant provincial programs that are in place?

Ben Reitzes:

I don't know. That's a great question. So I think a lot of this is modeled on the fact that Quebec has a higher labor force participation rate for women because they have affordable childcare that most other provinces don't have, especially I think Ontario is probably a pretty big target there. So it's likely intended, I don't think it's to supplant it, but supplement whatever's already there. I don't think the feds are going to come in and replace Quebec's system, but maybe they'll start paying for some of it instead of the province footing the entire bill. But the intention is to get women back in labor force, improve that participation rate a little bit more, which then leads to stronger long-term potential growth for the economy, and that's a benefit for the country.

Fred Nastos:

Of course, which is one of the reasons to put the programs forward. I guess we'll also be looking to see what COVID-19 support measures are continued.

Ben Reitzes:

Yeah. There's going to be plenty of those. I mean, they're kind of changing the EI program, the Canada recovery benefit. I mean, that's going to go probably through, I would guess at least the rest of this calendar year or something close to it. And the question then is whether they revert back to old EI rules or they make EI more generous in line with the changes to the CRB. And I think that that's an open question at this point. I suspect that probably won't answer that at the budget. I don't see the benefit for them doing that. The wage subsidy will probably continue as well. I mean, we're in the middle of the third wave here, so whatever's still in place likely is not going away. And we'll no doubt be extended at least through the summer.

Fred Nastos:

I guess another focus of the budget will be on their climate related taxes or initiatives there. What do you think is the base case on that front?

Ben Reitzes:

Well, they already have their carbon pricing blueprint intact and out there and escalating over the coming year. So I don't think it will be taxes from that perspective because that's already in place. It's probably more along the lines of incentives for green investments or something along those lines to help push the economy toward or to help push the business sector toward a greener future. What that entails, I think actually you would probably know better than me.

Fred Nastos:

I probably don't actually, but I guess I'm expecting to see some sort of corporate tax cuts for businesses that are working towards like a green economy or a low emissions or zero emissions economy. I'd be curious to see if they can never go through with some sort of green bond tax exemption or green bond tax exemption on the interest. That was circulated a couple of years ago. And that had an interesting market effect where green bonds really caught a bid for a few weeks going into, I think, the 2019 budget, if I remember correctly, but there was no... They didn't come through with anything there. But I know that in the 2020 finance committee report, I think that was a recommended measure.

Ben Reitzes:

I think that's exactly the type of thing that they could do at this point. The focus will still be on COVID and the recovery from where we are now, the continued recovery, but I think a lot of green type initiatives should be expected.

Fred Nastos:

Another area that everyone's going to focus on with the budget are any measures on housing.

Ben Reitzes:

We've already had OSFI come out and they proposed raising the stress test rate to 5.25 or two percentage points above whatever the contract rate is on a mortgage, and that would be effective June one. We heard from finance minister Freeland that the government probably wants to wait and see what the impact of that OSFI measure is before they do anything else. But I think domestically they're willing to wait. I think that there's still a decent chance that we get tighter measures on foreign buyers. They really try to clamp down a little bit more on that at this point, just in an effort to cool housing as much as they can and really support affordability for Canadians.

Fred Nastos:

How would that play out?

Ben Reitzes:

There's a lot of different ways to do that. Just a question of how restrictive they want to be. That's really what it comes down to. And what place foreign capital has in the Canadian housing market. You could make an argument that given the way the housing market's gone for the past 20 years, pretty much after being dead through the 90s, it's been on fire for most of the past 20 years, 15, at least, and we probably don't need foreign capital right now. If that's the conclusion that they come to, then you could see something pretty punitive there. I mean, just to ensure that you don't have foreigners parking money here and those houses staying empty. What you want to supply to be fully available to everybody just to ensure that everybody can have a place they need to live that's affordable.

Fred Nastos:

Right, so I think the recommendation there is something like a tax on vacant residential properties.

Ben Reitzes:

That one's difficult, though. How do you know if a property is vacant? How's the federal government going to keep track of that? Things like that, I think, are pretty challenging. I think a tax of some kind on foreign buyers when they come in, when they go out, something like that, is certainly on the table, I think, and then you could make it as punitive as you want, depending on how badly you don't want that money.

Fred Nastos:

Moving from housing, do you see any potential for increased taxes to help pay for COVID here, like a sales tax or luxury taxes or anything like that?

Ben Reitzes:

I think it's far too early to be talking about tax hikes. They still want to see the economy recover, and the way to do that is not raising taxes. And I think the way that they've approached the government's approached the deficit and the way it's been spoken about and their willingness to spend with a lesser concern on long-term finances and dropping their fiscal anchor, creating fiscal guardrails that give them a lot more flexibility on how much they can and are willing to spend. When you look at that all together, there's really no good rationale for raising taxes from that perspective. If deficits don't matter, then why would you want to raise taxes to lower the deficit? That just doesn't make a whole lot of sense.

Fred Nastos:

And to that point, I think the we've seen this over the past year or so the narrative on the debt and the deficit has really come down to servicing costs rather than a focus on the outstanding debt or deficit to ratio GDP.

Ben Reitzes:

Yeah, and that's been a theme and probably will be globally going forward until we see a big increase in interest rates. But that's the risk. I mean, the rates have been falling for 40 years. I guess that could definitely continue. I don't think it will personally, but I wouldn't rule that out by any means. Or rates can just stay low where they are now, and if that's the case, then you can carry a higher debt burden and it's not a huge problem, and you can use that ratio, you can use debt service ratio as your guideline, but if you get a big backup in interest rates, if 30 year bond yields rise to 3, 3.5, 4% or more, who knows, if you get an unexpected event, then that's going to be a challenge from a fiscal sustainability perspective. So it works for now and until it doesn't and then what happens? And then you're faced with some really difficult choices.

Fred Nastos:

On the topic of the deficit, then. I think we're projecting to see something like a deficit of 175 billion for next year.

Ben Reitzes:

Something in that neighborhood. I think 150 to 175. Again, it's going to come back to how much of that 70 to 100 billion they want to spend this year, if they're spending it at all, and how conservative they want to be with respect to forecasting around COVID because if the third wave lasts longer than expected, that would mean the support programs need that much more money, which would make the deficit that much bigger.

Fred Nastos:

It's 200 billion less than last year, but still about 100, maybe 150 billion above 2019 levels.

Ben Reitzes:

Yeah. That sounds about right. Big numbers.

Fred Nastos:

How do you think issuance will play out to the finances deficit?

Ben Reitzes:

I think if we assume that that the table stock stays relatively unchanged, that sets up issuance of about 250 to 275 billion for the coming year. There's about 105 billion in maturities. That's how you get to that number with a 150 to $175 billion deficit. Again, big numbers and more or less unprecedented. I mean the last year at 374 billion, that's a huge number. So issuance will probably fall about 100 billion or so. But luckily the Bank of Canada is there sitting on the sidelines and gobbling up debt one week after the next. So from that perspective, I think that there's a pretty good cushion for the government in there.

Fred Nastos:

So that actually takes us to next Wednesday's event, which is the Bank of Canada statement where we're actually expecting to hear them cut their purchases by about a billion a week.

Ben Reitzes:

Yeah, I think that's the broad market consensus at this point. We've been there for a while of looking for a one billion cut. They're currently buying four billion in government of Canada bonds per week, though we expect it to cut that down to three billion. And since that's consensus at this point, it's hard to think it'll have that much impact. I think the tone around that does matter a little bit in that where they cut their purchases from. So I think most are expecting the bulk of the cuts to come in the two and five-year sectors, which is where it has to come, because they're not buying enough tens and longs to cut that much.

Ben Reitzes:

I think that the narrative around that can be, if they choose to, they can extend their duration a little bit as well, and they can say, "Well, we're still providing as much stimulus as possible, but due..." I mean, it's really due to the fact that issuance is going to fall by 100 billion. They can't keep buying at four billion per week. They need to cut that down. So they can cite that technical factor is as, some extent, forcing them to cut their QE purchases a little bit, just because they don't want to have too large a footprint in the market.

Fred Nastos:

The problem I see, though, is if they extend the maturities of their purchases, they've already bought so many of the longer issues, Canada's debt is very focused on the shorter end. Although the issuance was termed out a little bit, dropping the issuance by 100 billion, it's not going to provide a lot of long-term debt for then Canada to buy.

Ben Reitzes:

No it doesn't. And I think that's exactly right. And that is, I mean, clearly an issue. They're buying 450 million of long bonds per week. Over the course of a year, that's just over 23 and a half billion or so. And if you assume the share of issuance stays the same per maturity bucket, so like last year, for example, longs were 8.6% of total issuance, 32 billion. If you assume that stays the same and you use a $275 billion issuance profile, that would mean the Bank of Canada is buying all the long bonds in Canada that get issued pretty much. And that's a problem.

Ben Reitzes:

I'm not convinced that they want to necessarily do that, especially when they're not going to be buying all the new issues. They already own huge chunks of the off the run. So I take your point. I think it's probably more likely that they take a little bit off of every single sector. Most of their cuts comes in twos and fives, and they take a little bit off the top and tens and a little bit off the top in longs, just to spread things out a little bit. Not huge amounts, but they do still bring them down.

Fred Nastos:

Right. So the bank of Canada could cut the total amount of purchases across the curve, but cut the shorter terms by more, thus extending the maturity of their purchases.

Ben Reitzes:

Yeah, exactly. So the DV01 would still go down, they're still reducing purchases across the curve, but it wouldn't be as impactful as if they had sharper cuts in the ten and long buckets. They're still providing that stimulus, so if you take for fiscal year 2021 that just ended on March 31st, net issuance was about -15 to -20 billion. That's bonds going to the public. For the coming year, it'll probably be around zero using the QE profile that I have and 275 billion in issuance. There are more bonds available to the public than there were last year, but it's still not as if the market is getting flooded at this point. So it should be easily absorbed. Their lower QE purchases shouldn't have that big of an impact.

Fred Nastos:

In terms of trading around the bank of Canada, though, are there any trades to go to you here in terms of either going into it or coming out of Wednesday's meeting?

Ben Reitzes:

I think there's a couple of things to think about. The biggest question going into this is when they expect the output gap to close, and that that's been in 2023, and that's been the driver behind their commitment to old rates at 25 basis points into 2023. And the question is whether that changes. I mean, we're going to have huge upgrades to the growth profile. Huge. They were way off on Q1. They had a -2.5 in January, and at the time things didn't look great and we didn't know that January was actually a pretty decent month. But Q1 looks like it's going to be +6% or so, something in that neighborhood. So you're going to get a huge increase to 2021 growth, even if Q2 will probably be on the soft side because of COVID.

Ben Reitzes:

So you get these big increases. So in theory that pulls the output gap closing forward probably into 2022, but at the same time every April they actually reevaluate potential growth. So they can do that in such a way that actually pushes the closing of the output gap further back, pushes it back into 2023 if they choose to. So it's a question of what message the bank wants to send. At this point I lean toward them keeping the output gap in 2023. I'm going to reserve my right to change my opinion on that over the next few days or so, but that's definitely where I lean. Again, we're in the middle of the third wave and the uncertainty around that suggest they'll want to stay on the conservative side of the spectrum. I mean, trade's going into this. Canada still looks cheap on a relative basis compared to really most other markets with a pretty aggressive Bank of Canada rate high profile priced through 2022 and 2023.

Ben Reitzes:

So I think going into this, I would lean toward being long, but at the same time, I'm a little bit reluctant given the fact that they are tapering, and last time they tapered, even if it was technical in October, you had a knee-jerk sell off right across the curve that was pretty notable. My bigger thought is I think you do want to be buying Canada across market, on weakness though, and for the purpose of just looking ahead a few more weeks, you go to the April employment reports that'll be out in early May, and Canada is probably going to be down a few hundred thousand jobs, and the US could be up over a million jobs. And that divergence is something you pretty much never see. So I think going into that, you probably want to be long Canada, so any weakness you get over the next, I don't know, two weeks or so, you get long Canada, maybe the Bank of Canada cutting their QE and the knee-jerk on the back of that provides that opportunity to get along.

Fred Nastos:

So I think what you're saying here is simply that with this third wave happening in the lockdowns that just got implemented in Ontario, the Bank of Canada wants to be a bit cautious, so we shouldn't look to see the OPA gap get moved forward at all. And in terms of trades, that seems to be the consensus view, that Canada is a bit cheap five years and shorter on the curve. It is interesting because except for that backup in late February, Canada on a cross-market basis versus the US is still historically very cheap here.

Ben Reitzes:

The issue is we've been cheaper in the near recent past. So even though historically, we look cheap, I think that the market is still looking at the Bank of Canada being more aggressive than the Fed at the end of the day, because the Fed's got average inflation targeting and the Bank of Canada doesn't. That brings a lot of people to the conclusion that the Bank of Canada is going to be moving first. To some extent, I agree that that's certainly possible and I can very much see that, but the Bank of Canada is not going to want to give that up at this point. I mean, they're going to play up that uncertainty angle again.

Ben Reitzes:

That's something they have been very focused on and will continue to be very focused on because as much as I think... Just because I think that the vaccines mean Canada will be a lot more open through the summer months and I think most of us should be vaccinated by the end of June, just because I think that doesn't mean I'm going to be right. There are uncertainties there. The variants could be a bigger issue than I think they will be. So the Bank of Canada can't just lean on, "Well, they think the vaccines will work," they need to wait until they do work and then they can change their mind. Rate hikes eventually are so far away that there's a lot of time for the bank to make a U-turn between now and then, and change their view. And now seems probably a little bit premature to be making that turn.

Fred Nastos:

In summary of what you're saying is that there's still a lot of uncertainty out there and the bank will lean on that.

Ben Reitzes:

Yeah, I think that's exactly right. And as long as that uncertainty about the downside risk is still there, they'll want to stay as cautious as possible. So I guess, Fred, thanks for asking me all those questions. Thanks for being the host this week, effectively. You take my job. If I'm not careful you'll be the new host of Views from the North. Any other questions on the bank or on the budget before we conclude?

Fred Nastos:

On a trade like Canada-US cross-market here say in fives or shorter, even, where do you think a good entry point is?

Ben Reitzes:

I think that right now it's pretty tough just looking at my screen. It's about nine basis points or so, Canada's back of the US. I'm not overly enthusiastic at this level. I think if you could get into the mid-teens, maybe 15 basis points if we can get there. I'm not convinced we'll actually get there, but something close to that I think is a much more favorable entry. We've been consistently cheap here, so that's why I'm not really excited to get into these levels. We've been notably cheaper. I don't think we get back to those extremes that we saw in mid-March. There's a decent chance, but again, on the knee-jerk from the bank of Canada's expected taper, that might be enough to drive that cross market spread to up to 15 or something in that neighborhood, and then that's where you want to try and get a long Canada.

Fred Nastos:

If you wanted to hedge that, say on another part of the curve there, would you suggest sort of tens or longs or something in between?

Ben Reitzes:

I think if you want to hedge that five-year trade, I think you'd do it in the long end. If you look at the fives 30s box Canada against the US, the Canada curve is relatively flat compared to the US, and I think there's definitely room there. I think if you just look at fives 30 Canada on its own, there's some room to steep in there. It's not quite a levels that I want to be steepening in personally, but on a relative basis, we are not far from the lows, Canada-US on that box, so that I think that's a good place if you want to hedge that five year exposure.

Fred Nastos:

So curve steeper in Canada versus a flatten on the US.

Ben Reitzes:

Exactly.

Fred Nastos:

Another point of the lift off of rates and who goes first, you can have a situation where the bank Canada maybe might go first, but then we stay on hold at a low rate for a long time while we wait for the US to hike up and take the lead on raising rates.

Ben Reitzes:

I think you got that exactly right. So that's kind of where I lean. Canada can go first, just because of the way our monetary policy is structured, our target is different than the US, and so , that likely means Canada goes first. But that doesn't mean we're as aggressive as what the market is priced. I think the pace of hikes is the issue for me, rather than the hikes themselves, like the starting point for hikes. If the US starts later than Canada, they are likely to be more aggressive in moving rates higher as they'll probably have to be, I think, at that point, especially if you consider the relative fiscal stimulus perspective, they're still more in the US, even if the government comes with a big package, they follow through with that 70 to 100, there's still more coming in the US. So there's plenty of room for the US to strengthen significantly from a macro perspective, so the longer the Fed waits, the more aggressive they'll likely have to be at the end of the day. So I think that's probably the biggest issue I have with market pricing right now.

Fred Nastos:

All right. That was great, Ben. Do you have any questions for me?

Ben Reitzes:

I think we'll wrap it up there for this week. Fred, thanks for coming on. Thanks for hosting me, I guess. We'll see what happens next week. Big week coming up. Thanks again.

Fred Nastos:

Thanks for having me on. Have a good week.

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 prepared with the assistance and employees of Bank of Montreal, BMO Nesbitt Burns Incorporated, and BMO Capital Markets Corporation, together, BMO, who 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. 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. 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 herein maybe suitable for you.

Speaker 3:

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Speaker 3:

This podcast is not to be relied upon in substitution for the exercise of independent judgment. 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 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 transaction or matter, and information may be available to BMO and/or its affiliates that is not reflected herein. BMO and its affiliates may have positions long or short and effect transactions or make markets in securities mentioned herein, or provide advice or loans to, or participate in the underwriting or restructuring of the obligations of issuers and companies mentioned herein. Moreover, the BMO's trading desk may have acted on the basis of the information in this podcast. For further information, please go to bmocm.com/macrohorizons/legal.

 

Benjamin Reitzes Director, Canadian Rates & Macro Strategist



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