Good Morning,
Welcome to this week’s edition of the Treasury Guy commentary. I was going to skip it but market volatility last week demanded some attention. That and the marketing department threatened to stop sending me cake from time to time if I didn’t write something.
Sidebar
This morning on the subway I offered my seat to another passenger. In return, she cursed me out and called me a misogynist. “I’m not a misogynist”, I replied, “I’m a misanthrope. I hate everyone equally.” (Credit to David Sedaris for the clever turn of phrase). For the record, I kept my seat and was very pleased with myself, but more misanthropic than ever.
Today’s Economic Data
Headline CPI inflation rose 0.1% month over month in May compared to consensus expectations of 0.2%. The year over year inflation rate drifted lower to 1.3% from 1.6%. Today’s miss on headline and core measures of inflation may cause the market to reconsider its expectations for a July rate hike but the case for October is still intact.
Bond prices are higher (yields lower) by 2-3 basis points following the CPI data.
Rates
Government of Canada bond yields are around 20bps higher than two Fridays ago. Maybe a little less following the CPI data this morning.
| | Today
| 1 week ago
| 2 weeks ago
| 4 weeks ago
|
|---|
5yr GoC | 1.13
| 1.14
| 0.95
| 0.96
|
10yr GoC | 1.47
| 1.52
| 1.42
| 1.44
|
The excitement started on Monday last week when Bank of Canada senior deputy governor Carolyn Wilkins told an audience in Winnipeg that the central bank is seeing signs of broad growth across regions and sectors. This is a good example of ‘hawkish’ talk by a central banker, and the market reacted accordingly. Canadian bond rates moved sharply higher and the Loonie jumped, rising above 75 cents U.S. for the first time since April. These changes are consistent with a market that is accelerating the projected timeline of BoC rate hikes.
Now to be fair, a ‘hawkish’ central bank is typically concerned about inflation, but despite annualized economic growth averaging 3.5% over the last three quarters, inflation is comfortably below the bank’s 2.0% target. Ms. Wilkins brushed off the inflation numbers as “transitory”. I guess she has the authority to do that. As an aside, Mrs. Treasury Guy was dissatisfied with my domestic efforts around the house recently. I attempted to brush off her concerns by describing my poor attitude as “transitory”, but it didn’t have the desired effect. I guess it only works for central bankers.
Anyway, there are a couple of risks threatening the promise of continued economic growth. Another fall in the price of oil (currently at a 9-month low) and uncertainty related to Trump trade, tax, and regulatory policy could put a damper on the economy. That or impeachment…whichever comes first.
We also can’t ignore the role housing may play in the bank’s decision making process. As the media has made abundantly clear, there has been a lot of hand wringing and teeth gnashing over the housing market, particularly in Toronto and Vancouver. The BoC has pointed to housing and consumer debt as risks to the stability of Canada’s financial system.
Despite these overhanging concerns, Ms. Wilkins speech makes it clear that the Bank may be rethinking its monetary policy. With the oil shock presumably behind us, Ms. Wilkins wondered if the “considerable monetary policy stimulus presently in place is still required.”
Higher interest rates would certainly have a desired cooling effect on housing and consumer debt but until recently, weakness in the broader economy has kept the bank on the sidelines. BoC governor Stephen Poloz backed up Ms. Wilkins hawkish chatter the next day and has now acknowledged that economic growth and housing risks are now pulling policy in the same direction.
BOTTOM LINE
The fact that the bank has elected to start talking in this ‘hawkish’ tone suggests that it wants the market to start seriously thinking about rates moving higher. The implied probability of a 25bp hike at the July 12th meeting has gone from <5% at the start of June to almost 60% as of yesterday. Those odds will be reduced today following the CPI data, but, what we’re saying is, there’s a chance.
Home Capital Update
By now I’m sure you’ve heard the latest. Warren Buffett has come to Home Capital’s rescue. Sort of. The endorsement of the value investing legend should shore up confidence in the firm but it didn’t come cheap. The equity portion of the deal will have a significant dilutive effect on existing shareholders and the terms of the $2 billion credit line are only marginally better than those of the deal provided by HOOPP in April. Nonetheless, you can’t put a price on confidence. Or maybe you can. The stock price soared 27% to $19.00 following the news and is now up 325% from its low of 5.85 on May 5th. (Note: HCG opened trading this morning up another $1.75 and last crossed at $20.75)
Canada Mortgage Bonds
In more practical news, Canada Housing Trust (“CHT”) issued its regular quarterly 5-year Canada Mortgage Bond (“CMB”) last week. Access to funding through the CMB program is limited by maximum allocations to participating MBS sellers. Allocations into the June transaction were, however, the highest since September 2014. The deal size of $5.25 billion was slightly larger than the typical $5.0 billion and MBS seller participation continues to be challenged by the impact of recent changes to mortgage insurance eligibility rules and the high cost of mortgage insurance. The bottom line here is more money for Treasury Guy. Giddy-up.
The CMB issue itself was well received and was priced 2.5 bps tighter than its initial launch in March. In fact, CMB spreads are another 2-2.5 bps tighter this week with continued buying both outright and vs provincials. (Note: the spread between CMB’s and provincials has been historically tight recently making CMB’s look ‘cheap’ on a relative basis). The next 5 year CMB comes in September and will feature a new December 2022 maturity date.
Final thoughts
Finally, Wednesday marked the Summer Solstice. Worldwide the interpretation of the event has varied among cultures, each recognizing the event with different festivals and rituals. Treasury Guy subscribes to only one Solstice ritual…a patio and plenty of cold beer.
Here’s mud in your eye,
Treasury Guy
Jason Ellis, Managing Director, Capital Markets