To say it has been an eventful year thus far for market and interest rate watchers would be an understatement. Pundits have been blindsided not once, but twice by the Bank of Canada on the direction for our national cost of borrowing… and it’s only March.
To recap: the long-held expectation that the Bank of Canada would hike interest rates this year was turned on its head in January, as our central lender implemented a surprise 0.25 per cent cut to its Overnight Lending Rate in response to lower oil prices. That caused a flurry as banks scrambled to respond with changes to their Prime rates and economists realized oil’s impact was a more urgent cause for concern than thought.
Markets took the BoC’s cautionary stance in stride, and overwhelmingly expected another cut to occur in the March 4th announcement – only to be derailed again by a speech made the week prior by BoC Governor Stephen Poloz, announcing measures taken thus far had been sufficient “insurance” against oil’s downfall. The BoC then held rates at status quo.
Now, as the April 15 interest rate announcement approaches, the jury is out on whether we’ll see any movement. In light of weaker jobs data and a continuous drop in oil prices, the chances of another BoC rate cut by May are placed at 35 per cent, according to a Bloomberg survey of economists.This contrasts with the stance released by CIBC last week that the BoC would take a “one and done” approach.
“Before (March 4) it looked like a matter of ‘when’ rather than ‘if’, as we looked to another rate cut from the Bank of Canada,” stated CIBC economists. “But in light of the most recent rate decision and policy statement, it’s no longer certain that Governor Poloz is set to ease monetary policy once again in an effort to insulate the economy from the worst of oil’s damage. As such, we are no longer looking for the BoC to cut rates again, with ‘one and done’ now the most likely outcome.”
Is the BoC Sending Mixed Messages?
Many feel that this rate-direction guesswork is causing unwarranted turbulence within the markets – and that it could be avoided if the BoC took a more transparent approach to its monetary policy. There has been criticism that Poloz is not as forthcoming in his communications as his predecessor Mark Carney – after all, last October he removed all forward guidance from the BoC’s interest rate announcements.
Forward guidance is a tactic used by central banks to communicate directly with markets about their interest rate intentions. As any change to central interest rates can cause markets to panic and swing, removing the element of surprise with forward guidance language can prevent them reacting to speculation, and causing real economic consequences.
When the BoC dropped their guidance, it stated that its stance on the economy should be gleaned instead from their economic forecasts and assessment of stability and risks.
Markets Miss Forward Guidance
This change to the Bank’s communications has not been accepted without some confusion, and has drawn ire from some investors, perhaps most notably from Pacific Investment Management Co. – the world’s largest bond manager. The investing giant sold off all of its government of Canada bonds, citing frustration with the BoC’s unpredictable communications.
Stated Pimco Canadian Portfolio Manager Ed Devlin to Bloomberg, “The Bank of Canada has confused the rest of the market and it’s confused me.”
U.S. Fed to Shake Rates Up Further
If you thought Canada’s monetary policy seems muddled enough, expect recent developments south of the border to further stir the pot. Improving economic and job conditions in the United States may prompt the Federal Reserve to raise central rates there sooner rather than later – and the impact will be felt globally. Update: the Fed has officially dropped their “patient” wording from their forward guidance in this week’s committee announcement. This isn’t akin to a hike, but will set the stage for liftoff in the near future.
What Will Happen if the U.S. Hikes Rates?
Because the majority of the world’s borrowing happens on a USD denomination, increasing the U.S. cost of borrowing will tighten conditions for borrowers everywhere. It will become more expensive to borrow in U.S. Dollars, and the USD would grow further in strength.
There’s also the question of how the BoC will react to a Fed rate hike; traditionally our Bank has fallen suit with U.S. rate direction. But that’s not the case today – doing so would mean a complete reversal of our current economic policy. Stated Rhys Mendes, one of the BoC’s economists, to the House of Commons last week, “The bank targets inflation in Canada and decisions regarding monetary policy in Canada would be based on the outlook for inflation.” His stance is that a U.S. rate hike would ultimately be positive for Canada, as a stronger Dollar would support our export industry, as our low dollar boosts non-commodity exports to our biggest trade partner.