Strap in folks, it’s been a whirlwind of a week and the volatility isn’t over yet. I had an entire Halloween introduction ready to go, but as my favourite philosopher Mike Tyson once said, “everyone has a plan until they get punched in the face”.
In this case, the violent move in rates is the proverbial punch that I think we can all relate to this week.
The move in rates across the curve this week was massive, but before I get to the exciting part and what it means for you, you’ll need some context. Our starting point will be the Bank of Canada’s rate announcement on Wednesday October 27th at 10am.
Goodbye QE, hello rate hikes?
On Wednesday, the Bank of Canada (“BoC”) released an updated policy statement, in addition to their October 2021 Monetary Policy Report. I would summarize the report as follows:
- The BoC formally announced the end of its balance sheet expansion, otherwise known as QE, but will maintain the size of their existing portfolio of Government of Canada (“GoC”) bonds. This will be done through a bond reinvestment plan, which means that as their existing portfolio of GoC bonds mature, they will reinvest the same amount of principal without adding any incremental stimulus into the system. Currently, the BoC owns $430 Billion of GoC bonds representing 46% of the total GoC issuance.
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Despite the BoC slightly reducing its economic growth forecast for this year, primarily due to supply disruptions, they still see the output gap closing in the “middle quarters of 2022” as opposed to “the second half of the year”. This change effectively pulls forward the timetable for a first rate hike from the second half of 2022 to the second quarter of 2022.
- Changes were also made to the Bank’s inflation and GDP forecasts. The Bank noted that inflation is running hotter and is more persistent than expected and amended their inflation forecast upward to reflect these inflationary pressures. The BoC also lowered their 2021 GDP forecast down to 5.1% from 6% and 2022 down to 4.3% from 4.6%, but raised their 2023 outlook to 3.7% from 3.3%.
A deep dive into the market reaction
Immediately following the release of the statement and Monetary Policy Report, the front end of the curve (the section of the curve that “prices in” rate hikes) shot up 26 basis points and reached as high as 1.13% – a level we haven’t seen since Feb 2020. The 2-year ended up increasing 20 basis points on the day settling in at 1.08%.
A large factor to the move in short term yields was also due to a technical component as investors scramble to get out of positions prior to any firm rate hike announcements. Cut your losses as they say.
The mayhem continued Thursday morning (October 28) before yields finally settled that afternoon. As of the open on Friday (October 29), the 5 and 10-year Government of Canada (“GoC”) bonds were trading at 1.46% and 1.69%, up 12 and 6 basis points respectively from the open on the morning of the BoC announcement (October 27).
The 5-year Canada Mortgage Bond (“CMB”) opened on Friday at 1.72% representing an increase of 16 basis points from Wednesday morning (pre BoC). The 10-year CMB opened at 2.10%, an increase of 7 basis points from the same time.
Credit spreads (the spread between the CMB and GoC) on the 5-year got hit hard this week and increased from 21 bps to 24 bps. The increase in spread was a factor of the limited liquidity in the market, as most market participants sat on their hands until the volatility ended. The 10-year spread widened out 1 basis point from 39 to 40 bps.
What does this all mean for you?
The first and most obvious impact is to your wallet!
Higher yields --> higher overall mortgage coupons --> higher mortgage payments.
If this is not managed accordingly, it could quickly have a negative impact on both your loan proceeds and your bottom line. I would be remiss if I did not tell you to reach out to our knowledgeable team of advisors and of course our fantastic treasury team here at First National to help mitigate this risk – it’s what we do and we do it well, if I do say so myself.
The second impact – with rates historically going in one direction, Canadians have never had a major issue servicing their debt. Some days, it even feels like it’s a patriotic duty as a Canadian to be as leveraged as possible. If the rise in rates persists, servicing our debt is about to become a lot more challenging and unlike the BoC, normal everyday consumers cannot just print money. A soft landing for consumers is not necessarily in the cards and impacts could easily reverberate to the overall Canadian economy.
Lastly, it is true that the Bank of Canada can raise rates and help keep some inflation under control, however at the end of the day, they cannot produce semi-conductors or unload shipping containers at ports. Without some of the key supply chain factors normalizing, raising rates may lead to lower growth and lower discretionary spending but your energy, repairs and maintenance and tax invoices may still be increasing. Spooky stuff as we lead into Halloween weekend.
Happy Halloween!
Neil