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What, Me Worry? - Views from the North

FICC Podcasts October 07, 2021
FICC Podcasts October 07, 2021

 

This week, Joel Prussky, BMO's OIS and cross currency trader joins me to discuss his view on the rates market, weigh in on the inflation debate, the Bank of Canada’s upcoming dilemma 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. 

Podcast Disclaimer

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Ben Reitzes:

Welcome to Views From the North a Canadian rates and macro podcast. This week, Joel Prussky, BMO's OIS and Cross Currency Trader, joins me to discuss his views on the rates market, weigh in on the inflation debate, the Bank of Canada's upcoming dilemma and his favorite trade ideas. This week's episode is titled, What? Me Worry?

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.

Ben Reitzes:

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 2:

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

Ben Reitzes:

Joel, welcome back.

Joel Prussky:

Thanks, Ben. Thanks for having me back.

Ben Reitzes:

It's a pleasure. This episode is the first one I think we're doing in person. I can see Joel's face instead of just listening to his beautiful voice through my computer. And then hopefully, this is a little bit more entertaining. Joel is always entertaining though. So I'm not all that concerned.

Ben Reitzes:

Why don't we start with the inflation debate and things are certainly heating up. I think the moves in commodity prices in particular are notable. And if you look at the move and rate markets over the past few days, I strongly suggest, or I strongly suspect, that it's being driven by oil prices moving higher and natural gas prices, moving higher. And the energy complex just really pushing that inflation question front and center right now.

Ben Reitzes:

Because I mean, it's been out there. It comes and goes. I mean, it hasn't really been that persistent per se, but I think oil nearing 80 bucks, natural gas at a 12 year high earlier today. Where do you stand on all this?

Joel Prussky:

Well, I mean, I definitely agree with you. I think when you look at things like energy, it's something that touches almost everybody. Right. I mean, much ink was spilled over lumber prices, mostly by people who wouldn't know what a piece of lumber looked like if it hit them in the head literally. But energy, we all have to heat our homes. We have to air condition if we live somewhere hot. We have to drive our cars.

Joel Prussky:

I think that hit home to a lot more people as opposed to, "Oh, let's read about things that are occurring elsewhere." But I do think it's important. The big debate out there has always been transitive or not transitive. And I think that's the wrong lens. I think that there are structural and cyclical things and you have to look at each of them.

Joel Prussky:

Because first of all, there's certain things you can do about structural and there's certain things you can do about cyclical. And the central banks of the world have tools that they can deal with some and some that they can't. I think that no matter what side of the debate you're on, you might be right for a time on one of those two things.

Joel Prussky:

The bottom line is, at the moment, it feels like structural and cyclical are in sync and that's painful. I am a big believer that the cure for high prices is high prices. There are cyclical things that will come down because eventually you will have a demand shock who will say, "I will not pay any more for that."

Ben Reitzes:

Lumber prices would be able to be a case in point.

Joel Prussky:

Perfect example.

Ben Reitzes:

Surging and then just collapsing back down to earth.

Joel Prussky:

Sure.

Ben Reitzes:

That's a fair point, cyclical versus structural. Good points as well. I guess that the question is, how long are the structural issues going to last? And that's really where the debate kicks in I think, and the question marks are. Is this six months, 12 months, two years? Or is there something bigger going on? There are bigger things afoot in structural changes in the global economy. Are those going to last long enough to keep inflation high enough to make central banks more concerned, more hawkish generally than they have been for...

Joel Prussky:

Twenty-five years? Sure. I mean, they've never really had to engineer a slowdown to put the boots to inflation.

Ben Reitzes:

Since the 80s.

Joel Prussky:

For most people's time in this market, I mean. And the amount of leverage in the system I think is way higher than it was back then. Incrementally, them raising rates is even more effective.

Joel Prussky:

And then, they also have to talk about what it is they target. I mean because in the US I think arguably, they would say, "Well, the 30 year rate, there are mortgages is so important in Canada." It's probably the five-year rate for mortgage reasons. Does it matter if overnights zero or three quarters of a basis point for the average guy? I mean, he might feel it a bit, but we could have a bond conundrum again. And the Fed could try to raise rates and the curve could flatten because they could price impulse and mistaken at the end. All that does is push real rates even more negative.

Joel Prussky:

I think we're kind of in unchartered territory, I think the Powells and the Macklems of the world are sitting there holding their breath, saying, "We hope this is transitory. And that means maybe another six months or nine months. And then things will come back down." But if we're in a situation where people start demanding wage gains. And I don't mean McDonald's workers getting $18 an hour or 1,19. I mean the unions start pushing the average salaried employee says, "Wait a minute. My grocery bill is going up 15% and I'm doing with less. We have to do something about that."

Ben Reitzes:

So you said Macklem and Powell hoping that it only lasts six or nine months. But what happens when we get let's say six months from now, we're still there? I have September CPI, I'm getting something in the order for Canada, something over four and a half percent year over year, which is a big number. We haven't seen those kinds of numbers in an awful long time.

Ben Reitzes:

Let's say we're still in three and a half plus by the middle of next year. So you're talking to pretty much nine months from now. Even if Powell and Macklem are hopeful that it's transitory, is the market going to accept that? At what point does the market step in and say, "You know what? I want some premium, I want some inflation payment. I want some risk premium in this. I am no longer willing to buy your bonds at whatever the yield is. I want more."

Joel Prussky:

I mean, that would have happened already. If there was an available free-floating market in fixed income securities, which there hasn't been for the better part of 10 plus years, but especially so now, where the Fed scoops up all the supply. If the Fed was not…

Ben Reitzes:

They are tapering. They are, let's say that, and they're tapering.

Joel Prussky:

But so far, they haven't tapered, and they're still buying that amount of bonds every month. Arguably the taper should have started three months ago because tapering is taking your foot off the accelerator. You're talking about when do they start putting the brakes on? They can't even start talking about taking their foot off the accelerator yet.

Joel Prussky:

I mean, at least the Bank of Canada has started down that road, but the bond market is global. And as long as there's negative yields in Europe, treasuries look somewhat attractive and the Fed is buying enough of them that the float on them is small enough, that yields are artificially low.

Ben Reitzes:

So there's no way out?

Joel Prussky:

I mean, I think the central banks of the world, you either believe that or you don't believe that they've been politicized over the last decade. If you believe, as I do, that they've been politicized, then we're embarking down a road that I think will have a lot of things hidden behind doors, once they are willing to open those doors or those doors will be willing to be opened for them.

Joel Prussky:

And as you say, term premium is one of them. We could walk in here one day and rates could move 40 basis points because there is just collectively no bid. And everyone says, "You know what? There should be risk premium. And why are ten-year bonds yielding 1,55 when inflation is still running at three and a half percent?"

Joel Prussky:

And unless you think the Bank of Canada or the Fed is going to embark on an aggressive tightening campaign and really make a policy error. And I tend to think these guys A, are smart-ish enough and B, they have masters in Ottawa and Washington that will not allow that to happen because this is not the Fed of the 80s.

Ben Reitzes:

So that's the question for me is, and I think that will be the question for the market in the early part of 2022. When we have still persistent inflation, because it's not going away in the next three, four or five months. I just can't. There's still way more price hikes coming through the pipe because I could see them personally. Anecdotally, I have plenty of those to share.

Ben Reitzes:

And Canada's case in particular, you have second quarter growth was weaker, than expected at least. Third quarter will also be weak and it's not going to be terrible. Trade was pretty good for August. That's going to help the third quarter a fair amount, but still, it's going to be weaker than the bank thought. It's hard to believe that the fourth quarter is going to be a lot better.

Ben Reitzes:

Just, I mean, given that COVID, I mean, is going to push everybody indoors. We're not going to be fully reopened probably until the spring at the earliest, I think. And so, you're still going to have that dampener on activity. And so, you're not going to have that full rebound and you've had some disappointment.

Ben Reitzes:

And so, you'll have a disappointing economic backdrop relative to what the Bank of Canada wanted and a higher inflation scenario. And so, at what point is the bank going to say, "Oh, well we care more about inflation than we care about growth or the output gap"? Or maybe I should put it a different way. They're more afraid of the tail risk to inflation being a much fatter tail and it being much larger on the upside. And so they need to do something about that before things get too far.

Joel Prussky:

I think that's the question. Right. I mean, they claim to have one mandate, which is an ablation targeting. We both know that's true and most people listening will know that that's not actually in reality. Because if that was the case, other times when we've exceeded target or gone below, they would have done something and they always tend to look through it, usually when it goes too high.

Joel Prussky:

I think that's really for the next three months is the question. Because everyone's models will say the opal gap has been pushed out. That's a fact. And does that get negated by the still persistent levels of inflation, which maybe still puts us then. If that's the case, we're on track for second half of 2022 for tightening. Which is pretty much where we're priced.

Joel Prussky:

Arguably, a little bit earlier than that. I think we have the first full tightening, I would argue is priced into June because of course, trade is quite a bit below target. And we have now three hikes by the end of 2022.

Ben Reitzes:

Almost. 65 basis points. But do you think that's appropriate?

Joel Prussky:

I think if the Bank of Canada tells you that the inflation concern outweighs the output gap, then yeah. Then that's probably not appropriate. If they come out this month and say, "We still think things are transitory and we had a big miss on growth," then I think the market probably has some repricing.

Joel Prussky:

I think nonetheless, steeper curves are coming. I mean, that's been a familiar refrain of mine for a long time and I think it still holds true. Maybe because third premium comes back into the market. I don't see a world where we pull a Tiesen and raise 100 bps. I just don't think we're in that world.

Joel Prussky:

I think you would kill everything and sentiment above all. We're just out of a two year hell. The last thing you want people to do, people who've stretched to buy a house, is to just find out that their mortgage payments have just gone up 20% because that's inflationary too.

Ben Reitzes:

I mean, that just pushes the dilemma that much further for the bank, that even if they are worried about inflation, how much can they really do? If every 25 basis point rate hike is that much more impactful and slows things down that much more than it did five years ago, 10 years ago, 20 years ago, how aggressive can they even be?

Ben Reitzes:

And I mean, notwithstanding the fact that rate hikes don't do anything on the supply side of the equation. It's not as if it's going to improve shipping times or aluminum prices are going to fall or any of that kind of thing. They're going to be in a really tough spot next year. I don't envy any of the central bank governors.

Joel Prussky:

Well, they aren't really that used to dealing with a supply side shock. Right. It's always been a demand side shock and the answer is always drop rates, borrow from the future. And when it's the future, it'll be something else's problem.

Ben Reitzes:

Supply side has been the other side of the equation. Sorry. The move in the supply side has been the other ways and that curve has been pushed out, instead of coming in. And there's been almost unlimited supply of labor globally. And that arguably, I think a big reason why inflation has been as subdued as it has been for 20 plus years, is that addition to the global labor supply from China, Eastern Europe, you name it, lots of different parts of the world.

Ben Reitzes:

That's not gone, but not what it was 20 years ago. And so, things are definitely going the other way. And you have again, energy prices. And when you already have producer margins under pressure from the first round of energy price hikes, tightening labor markets and rising general commodity prices, not just energy prices. Plus you have probably pretty strong demand generally and then just shortages of other items.

Ben Reitzes:

And then you add in another layer. So, the extra layer in this case would be the latest round of energy price increases. Natural gas moving higher and oil moving another 10 bucks higher. It's going to be very difficult for those prices not to get passed along. I think any marginal move in prices, any shock you get now, will get passed along way more quickly than it would have a year ago. And so, the risks to inflation are that much higher.

Ben Reitzes:

It's hard for me to see things really getting much better from here in the near term. At least almost till the middle of next year, when the supply issues at least start to improve. You get the semiconductors start to improve. Autos can actually get produced again. If you want to buy a car now, good luck. There aren't any.

Ben Reitzes:

And then the price of pretty much everything, not everything, but a lot of things are going to go materially higher. I just purchased something for my backyard a couple of months ago and the guy said thankfully, we already purchased it. And I put this on my other weekly this week, but he just came and he told my wife. He was over at my house today and he said, "Oh, good thing you already ordered it. Any orders after November 1st are up 30%." That's a monster price hike. And so this is just a sign of things to come I suspect.

Joel Prussky:

That will eventually flow through to demand because there are people who will... I know how some balance sheets are in great shape. And there is a lot of that stuff. But at the margin, people will say, "You know what? Screw it. I can wait." Okay. If you sold your car and you don't have a car, you need a car. But if you drive a three-year-old car and you're used to leasing it every three years, you can buy that baby back at the end of your lease and you can drive it for two more years, if you have to.

Joel Prussky:

I mean, it's a question of adjusting to a lifestyle. And we're in a place that's never really happened before. People are resilient and they will figure it out. And I do think you will see that we had a huge demand for goods at the beginning of the pandemic. And of course, way higher than trend. And I absolutely expect that to fall off a cliff.

Joel Prussky:

First of all, you only buy so many things for your backyard before you don't need anymore. And then the price gets too high. And I think you're going to see the demand for goods go down substantially and the demand for services even that out a little bit. Or we'll start to see a lot more growth on the service side, but we're in unchartered territories here, Ben, I think.

Ben Reitzes:

You'd be surprised what I can buy for my backyard. I'll just say that. Staying with the Bank of Canada and the aggressive pricing that the market has, I think it's important to compare that to where the US is priced, where the Fed is currently priced. We're looking at something in the order of the Bank of Canada being more than two hikes ahead of the Fed. I mean it's as much as three hikes. What was the maximum that we got to earlier this year, when pricing got really extreme? And how much do you think is even reasonable on that?

Joel Prussky:

I think in the summer blowout, we got to about three hikes ahead of the Fed. And quite a bit earlier. Not only three hikes, but three hikes quite a bit earlier than the Fed would start. And we're almost back to that point now. And I think there's a practical limit to how much the Bank of Canada will hike ahead of the Fed. And I think that limits realistically 50 basis points. I think much after that, it would be hard for them to get ahead there.

Joel Prussky:

I do think the one thing that the market in both countries is probably not accurately pricing is, if we talk about all the things you just said, and that inflation stays up here for the next three, four months. And then what they see on the horizon is that it's not coming down. Transitory is, we think it's about to come down. And four or five months later, it's not. And then whatever, for whatever reason, their models show them something different.

Joel Prussky:

The market's basically saying, well, the Fed's not going to do anything until the end of '22. And the Bank of Canada is no way doing anything until June, July. But there's a lot of runway between now and June in Canada. If they really believe that the lower bound is not necessary at the moment. And maybe we're not embarking on a 200 basis point hiking campaign every three months. But maybe we want to get rates from zero to 50 pretty quickly and see what happens there.

Joel Prussky:

And the Fed can also very quickly change their tune. I mean, people make a mistake of, first of all, believing what they say. What they say lasts about three days at the most, and then regular market forces take over. But also, just because they said something three weeks ago, doesn't mean it won't change three weeks from now. Things change. That's called life.

Joel Prussky:

I think when you look at things like aggressive three hikes priced by the end of this year in Canada, it's hard to quibble with that possibility, but to sit there and say, "Well, nothing's going to happen until June." And you have things like March meeting trading around target. I mean, it seems to me like that's being a little on the aggressive side in terms of how little you're pricing in to the chance of a hike earlier then June.

Ben Reitzes:

I guess it's a question of how much the bank believes inflation dynamics have changed from the past decade.

Joel Prussky:

We don't…

Ben Reitzes:

I don't think they're going to know by that. I think that's part of it. There is a risk there. Right. I do agree that may be things change. And maybe I'm not worried enough about inflation. If I'm even wrong from that perspective, inflation heats up even more, then I could see them being a bit more concerned. But even in my scenario and inflation stays north of three and half percent, because that will still be down a point from where we'll be in September.

Ben Reitzes:

You'll still be seemingly trending lower, whether we are actually continuously trending lower or not, I don't know. But seemingly trending lower, that should ease their fears at least a bit. On the pricing, how do you view positioning in Canada right now? Because that's, I mean, at the end of the day in Canada, if you don't know that you don't get much. And that's what caused that blowout in the summer.

Joel Prussky:

Yeah, I think positioning overall is definitely cleaner from what it was in the summer. Summer, you had a lot of guys who were all long and that just weren't getting the satisfaction and you had some crazy price action where Canada was selling off on days the US was rallying. And I got that.

Joel Prussky:

I don't get the impression at the moment that positions are too one-sided. We're going back to those cheaps. But I think the difference now is, after guys getting blown out, the levels we're at now is where they're starting to get into the trades before they were in at quite a higher level.

Ben Reitzes:

All right. You'd look at receiving one year, one year, Canada, US or something.

Joel Prussky:

Yeah.

Ben Reitzes:

Something like that.

Joel Prussky:

Yeah. I think that's probably the area that would be the most attractive.

Ben Reitzes:

Any other trade ideas?

Joel Prussky:

Trades I like at the moment, I mean, there's some stuff in OIS. I mean, we're starting to really compress it NPR to non-NPR meetings and then really blow out the non-NPR to NPRs, to such a point that I think we're getting in the risk reward is just getting a little bit skewed. I mean, every meeting is live according to the Bank of Canada.

Joel Prussky:

I think as those spread of spreads meetings start to blow out into almost 10 basis points, you really look to fade that. The cross-currency curve is as illiquid as ever. All flow related and lack of dealer risk taking. There's a whole bunch of weird stuff there. If anyone's really interested, they can speak to me. But I mean we have things like one-year, cross-currency gaps of the six year, one year versus seven year. One year is positively slope, but five-year, one-year, six year, one-year is negatively sloped. Really weird stuff. It's a micro level, but for the right guys, it's a trade.

Joel Prussky:

Other than that, I think rallies are made to be sold. And I think you pick your spot. In Canada, it's the belly. It's fives. It's tens. Because if the Bank of Canada's aggressive, fives will get two, but it doesn't mean 10s of good value. I get that when you open trading for dummies, it says when Fed hikes, curve flattens, but that's usually because we're at such a steep level to begin with. This is some of the flatter curves we've ever had. I'm not sure that putting on the flattener at any price makes sense. It might not sell off as much as three-year bonds might. But other than that I think the market has been becoming less and less tradable and more and more risk averse.

Joel Prussky:

I mean, I think it started getting bad in 2000. It got really bad in '08. Got a little bit better, but I mean, since this stuff has happened, it's gotten worse and worse. And dealer tolerance for risk is really low and it makes it a lot harder for the miners liquidity providing a lot. But what it does mean and the positive thing is dumb things tend to get dumber. And the dealers not willing to warehouse risk means things can get really crazy and you just have to be on the lookout for that stuff. And what I consider low-hanging fruit trades that used to come around once every three to six months, I think come around once every month now.

Ben Reitzes:

Well, that's good to know. Well, we'll have to watch your morning emails.

Joel Prussky:

Not just in my world either. I mean, it's bonds, it's swaps, it's everything. Right. There really is, there's no desire to take risk anymore. There's no such thing as a good trade. Dealer takes a trade, it's considered not a good trade. Let's get out of it. And I think that leads to choppy markets, which leads to opportunities. You have to be patient, you have to have your eyes on the ball for when it does come.

Ben Reitzes:

On the NPR and non-NPR. I think anything beyond the first hike, I think then those kind of gaps make no sense. The pricing the big premiums. And I guess there are more rate hikes in the NPR meetings, because they can go back to back meetings after the first one. The first one has to probably be in an NPR meeting because I suspect that's just what they want to convey that messaging. But after that, the curve probably should be a little more, I guess, linear.

Joel Prussky:

I mean, they could fix it. They could just have a press conference after every meeting and remind everyone that every meeting is live and the market will be more liquid. If we're going to go to RFR from CDOR and that's going to happen one day, can't be done without a liquid front-end OIS market. And at the moment, the Bank of Canada is doing everything they can to prevent that from happening.

Ben Reitzes:

Well, we'll keep pounding the table on that. Next time you come, I'll let you talk for 20 minutes on that one. Joel, good to have you. Thanks for coming on the show again.

Joel Prussky:

Thanks, Ben. It's a pleasure.

Ben Reitzes:

Great to see you in person.

Joel Prussky:

Always. Thanks again.

Ben Reitzes:

Thanks for listening, everybody. 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 prepared 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.

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 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, but just for the general information of our clients. It does not constitute a recommendation or a suggestion that any investment or strategy referenced herein may be suitable for you.

Speaker 2:

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

Speaker 2:

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. You'll rely solely on advice from your qualified, independent representative in making hedging or trading decisions.

Speaker 2:

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.

Speaker 2:

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 affect 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, BMO's 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 Director, Canadian Rates & Macro Strategist

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