The truth is, the Central Banks are trapped

It’s hard to say, but it’s the truth. BOC Governor Macklem’s refusal to raise rates until the Spring of 2022 is simply an admission that the BOC is trapped. If it raises rates, our economy will face more strain and middle class quality of life will be squeezed from higher debt servicing costs. If the BOC crosses its fingers and hopes inflation will go away (which it won’t), middle class quality of life will be squeezed from higher prices. When you keep interest rates at record lows for such a long period, ultra-low becomes the new normal – and it’s hard to take the punch bowl away.


Our economy is incredibly dependent on debt. We’re all depending on our credit cards, mortgages, and lines of credit to keep enjoying the quality of life we’ve been used to. We’ve gotten used to having cheap debt literally thrown at us for years now because of its overabundance. Never in human history has it been so easy and convenient to borrow. For years pundits, academics, and politicians have sent the signal that credit is better than saving, that debt and capital are the same thing, and that borrowing to spend always leads to prosperity. The old mantra was that capital was the accumulated savings of deferred consumption. That you saved and invested. That you invested and produced. That the banks paid you a healthy interest rate to put your money in a savings account. The old mentality was that prosperity was hard won by hard work and sweat – ultra-low interest rates changed all of that.


Unlike the U.S., Canada does not control the world reserve currency. International markets do not need to buy our debt and accumulate our currency reserves to trade. This privilege has allowed America to spend and borrow massively, to live beyond its means, and to export its inflation to the 2nd and 3rd world. The more the BOC puts off rate increases, the more rapidly and suddenly it will have to raise them if inflation continues to go up, or gets out of control – and then we’re in trouble. Either way, Macklem is trapped, and he knows it.

On The Bank of Canada’s Latest Thoughts (on the economy and interest rates) Part II

Inflation took up a lot of the statement, as was expected. Let’s summarize what the BOC said. First, they acknowledged that the inflation rate exceeds their band. It’s not at a level they’re comfortable with. They then point out that the big driver was gasoline prices, which collapsed at the onset of COVID, and have now returned to their more historic norm – this had a very big impact on the CPI. The BOC continues this point, arguing that many other prices which fell from a drying up of demand when COVID hit rebounded, taking another hit to the CPI metric. And finally, they then point to the international supply chain situation (bottlenecks, shortages, logistical issues, border closures, lack of raw materials, pullbacks in production, etc.). They point out that the overall supply chain complication had a big and fast impact on prices.

Overall the Bank’s logic and argument is strong and well thought out. They humbly admit that “we expect the factors pushing up inflation to be temporary, but their persistence and magnitude are uncertain, and we will be watching them closely.” This is an important sentence. The key point the Bank is making is that high gas prices, price rebounds, and supply chain concerns will all more or less go away by the second half of 2022, when they expect inflation to return to 2%. This is the big question. Finally, the BOC says that their bond purchasing program, or QE, will continue until the economy goes back to more normal growth and inflation subdues.

We can’t underscore how important this statement is, and how important the BOC’s next steps will be. If their analysis holds, we’ll have low rates continue, growth and inflation normalize, and a very comfortable landing from the difficulties of COVID. If their analysis and decision making is off, and if the boat is rocked, we may be in for some ongoing and longer term financial and economic difficulties. Fingers crossed.

On The Bank of Canada’s Latest Thoughts (on the economy and interest rates) Part I

In this blog, Tembo will dig into the BOC’s latest major statement to the media and the public from mid July, to try to understand the Bank’s analysis of the macro-economic situation Canada finds itself in. What the Bank does in the coming months and years will be crucial to how our economy and society fares at this point of our history.

First and foremost, the BOC is very optimistic and confident of medium to long term economic recovery. The Bank sees the worst of COVID behind us. It cites the overall resilience of the economy and the high efficacy of vaccines as key pillars of stability and strength. Despite these positive forces, the BOC still expresses some uncertainty over how ‘smooth’ the recovery will be, the course of the virus, and how international economic, virus, and financial conditions change. They have no crystal ball, and they don’t pretend that they do. The BOC does point to strong U.S. economic growth and stimulus, along with oil prices recovering as key forces which will benefit Canada and uplift economic growth here.

The BOC sees consumption as being the key domestic driver of recovery: “Some of the sectors hit by lockdowns, including retail, restaurant, and other hard-to-distance sectors, are already seeing a rebound, while others, like business and international travel, may take longer to recover.” The BOC makes the important point that there’s still half a million jobs that must be regained for us to return to pre-COVID levels, but also says that many businesses have optimistic plans to return to full capacity soon. The expectation is that we’ll recover those jobs as people continue to engage economic sectors most hit by COVID (restaurants, retail, bars, services, etc.)

The BOC remains confident that the rest of this year and all of 2022 will see strong, consistent, and sustained economic growth. If the BOC is correct, GDP will go up 6% this year, 4.5% next year, and just over 3% in 2023 – marking a healthy period of recovery ahead. Let’s hope they’re correct, we continue with Part II.

COVID-19 is changing the game

The disease that started off as a regional Chinese health challenge has now become an international economic concern that is spreading unease and uncertainty.

Tembo gave a brief outline of the disease’s situation and status in its last blog and newsletter but the situation is rapidly changing by the day. In Italy, the number of cases and deaths is beginning to pick up and the government has declared a nation-wide quarantine affecting many millions of people. Initially the Italians quarantined a few northern regions, particularly the region of Lombardy – home to Italy’s major stock market, key industrial assets, and economic hub. That quarantine is now being covered to a greater number of regions. The Italian Prime Minister cautioned all Italians to be mindful of the risks of the disease and to stay at home and indoors if possible. In Iran, the rate of new cases and deaths is rapidly picking up, while the signs from China is not all gloom and doom, with some calm reemerging and President Xi visiting Wuhan – the epicentre of the disease.

The economic uncertainty created by the disease is being intensified by the massive fall in oil prices – the biggest in 30 years. Russia and Saudi Arabia could not come to a conclusion on oil supply output. Both OPEC, and OPEC+ failed to come to a consensus on oil supply to the market. Subsequently, oil prices have fallen rapidly and the Canadian economy and the Canadian dollar are being negatively affected. It is estimated that Canadian GDP falls by over $37 billion with every $15 drop in oil prices per barrel. Our economy is highly dependent on energy – and will remain so for many decades. Market demand for oil was falling well before the outbreak of the disease, and the uncertainty of the disease is itself weighing down on demand and dousing out consumer confidence. 

In North America itself, as well all know, the BOC (Bank of Canada), and the Federal Reserve cut their rates by 50 basis points last week. The BOC finally added some commentary to their decision, claiming that they weren’t worried about the real estate market overheating, and that the rate cut would boost consumer confidence. This week, we’ve seen markets around the world take big falls. In the U.S., the Dow fell by over 2,000 points on Monday. In France the CAC fell by over 10%. Tuesday saw a brief recovery but there is profound uncertainty about the long term trajectory of the market. The Bank of Canada has also said that it will not hesitate to cut rates further if the need arises. The Federal Reserve has not yet made such a claim but the President is calling for more stimulus, lower rates, and more proactive leadership from Fed Chair Jerome Powell. COVID-19 is changing the game and intensifying unease and fear around the world. 

The BOC & the Fed up the ante

Well it happened, the Bank of Canada took an emergency rate cut decision, we now have interest rates that are 50 basis points lower (0.50%) than where they were. The expectations for a rate cut were powerful. There was almost no expectation of a status-quo. Given that the Fed cut rates, the BOC (Bank of Canada) was forced to emulate.

The overall Canadian economy has been slowing, well before the outbreak of the coronavirus. GDP growth, job growth, and overall dynamism were well on the decline. In particular, the trade war with China was just one of the myriad problems which was weighing on the economy. The end result of this rate cut will be to see the real estate market gain added momentum. Media headlines of this have been firm. One story put it very bluntly by suggesting the rate cut decision would put ‘kerosene’ to the real estate sector. One way or another, the Bank’s are likely to all pass on the savings to consumers and mortgage holders given the competitive nature of the market. 

Federal Reserve Chair Jerome Powell took an aggressive turn in adding stimulus to the U.S. economy and mitigating the impacts of the coronavirus by cutting interest rates by 0.50%. The move was not unexpected, and was in many ways called for, but the scale of the cut is big and the forcefulness of the decision had a reactionary feel to it. The Fed’s build up to the cut was not as comprehensive and gradual as they have been in past years. Chair Powell’s press conference announcing the cut was poorly received by stakeholders, and some believed that he failed to inspire confidence in the broader economy. Strangely, market reaction to the cut was the opposite of traditional patterns. The selloff that was initiative by unease over the supply chain, tourism, and broader economic anxieties of the spreading virus intensified after the rate cut was announced. It’s likely that market participants felt that the cut was excessive and that the rationale behind it suggested a significant degree of unease over the economy.

In late February the Conference Board of Canada released a report in which they provided a snapshot for the next two years for every provincial economy. For Ontario, the report predicted challenges with trade, lower government spending as a percentage of the economy, and modest changes in wages, benefits, and income. However, the same report suggested that a broad based recovery in residential, commercial, and industrial construction would intensify this year and in 2021. A return of greater levels of foreign investment, lower interest rates, and continued employment growth were all cited as factors which would take the building sector to new highs. 


A Coronavirus Related Rate Cut?

News keeps building on the spread of the coronavirus around the world. South Korea has reported a thousand cases of the disease and over 50 deaths, with these numbers rapidly rising. The South Korean Government has responded by emulating the Chinese in quarantining whole cities.

Keep in mind that a little over a week ago South Korea’s coronavirus numbers were negligible. Cases of the virus have been reported across South Korea’s demilitarized border in the notoriously isolated North Korea – despite that country shutting down its borders, and even reportedly executing the infected. But the coronavirus is spreading well beyond East Asia. Iran is reporting a rapidly growing number of cases and deaths despite a negligible presence of the virus not long ago. Iran’s Minister of Health was recently seen delivering a press conference on the virus sweating profusely, coughing, and appearing weak – a sign of the severity of the outbreak, according to international media.

In Italy, the virus is rapidly spreading and prompting reported shortages of goods in stores and growing unease. These are the most high profile country cases of the global outbreak, with fear growing around the world, especially in Hong Kong, Taiwan, Japan, and Singapore. Over the last several days, media attention on the outbreak has become increasingly fearful and the apprehension has already hit international stock markets. U.S. markets are falling precipitously and experts are warning that the virus’ impact on international supply will be severe and widely felt. As we all know, China is the workshop of the world and the planet’s biggest exporter of goods ($2.5 trillion annually). Chinese companies are involved in the production processes of everything from steel to pharmaceuticals to computers to drones,. If Chinese factory output remains negatively affected by worker anxieties over the virus, global supply chains will be damaged.

In response to this intensifying and ongoing issue, financial experts and economists have already begun to call for the Federal Reserve to cut rates. The Wall Street Journal is following and reporting on the outbreak closely and featured an article where the rate cut argument was made. The front page of the paper ran a headline stating that the virus was beginning to take its toll on the global economy. The supply chain pressures experts are warning about have yet to be truly felt. The Federal Reserve is obviously monitoring the situation carefully and has not yet provided detailed comment on the virus outbreak. This goes for the BOC (Bank of Canada) as well. It is likely that if the severity of the virus continues to accelerate and if global markets continue to be negatively affected there could be a comprehensive international response – central banks acting in unison to stimulate the world economy. 

Regulators are concerned about the real estate market – again

The activity we’re seeing the real estate market is raising red flags with federal regulators and the Bank of Canada. When the 2016-17′ boom reached its peak governments at all levels rapidly intervened to cool activity.

We all remember the introduction of the foreign buyers tax, tighter mortgage approvals, the mandating of mortgage insurance at certain levels, etc. These government interventions succeeded, eventually precipitating what was effectively a flat-lining of prices and a slowdown in demand. Once the shock subsided and the market adjusted, the recovery kicked in though, rendering the government action a grand delay. We’re now not far off from the 2016-17′ boom peak. The boom is back, and the apprehension is back with it.

Bank of Canada Governor Stephen Poloz summed up his opinion on the present status of the housing market with one word – “froth.” The BOC (Bank of Canada) notes that the rise is unsustainable and expects the market to naturally self-regulate if the rise in prices becomes excessive for prospective buyers. As always, the BOC is standing by to raise rates in the event that inflation and housing price growth becomes excessive. This is a worst-case scenario, and in many ways, softening national economic growth would spur the BOC to cut rates instead. The BOC will definitely monitor real estate stats closely in Q1 & Q2 2020 and will review its options if the housing momentum we’ve discussed intensifies. 

As for the provincial government in Queen’s Park, it is unlikely to interfere in the housing market in any way other than stimulating the growth in supply (cutting developmental approvals). The federal government is also limited in its capacity to address a hot market as it must balance affordability with controlling demand. A federal election is also soon on the horizon, which will see activity designed to increase supply and facilitate easier buying of housing, not the opposite. At the end of the day, if regulators and bureaucrats feel that the housing market is getting out of control they will move rapidly in concert with the BOC to add new measures, despite any political pressures. 

The BOC holds

Bank of Canada Governor Stephen Poloz surprised no one when he announced that the Bank of Canada’s interest rate would remain unchanged at 1.75%.

As Tembo outlined in our past post, analysts were divided over whether the Bank would emulate U.S. policies and cut rates or maintain them where they are. But the Governor’s carefully analyzed speech was also littered with a number of poignant warnings:

“Canada’s economy will be increasingly tested as trade conflicts and uncertainty persist. In considering the appropriate path for monetary policy, the bank will be monitoring the extent to which the global slowdown spreads beyond manufacturing and investment.”

In other words, we’re in for ever more difficult times. This was an important warning. The Bank followed up the warning by stating that global economic growth would slow this year to its lowest levels since the 08-09 crisis. The Bank acknowledged that its counterparts around the world have all eased interest rates but it is proud to be standing firm on its decision. The Bank is giving itself wiggle room in case the economy slows into a recession and the slowdown extends past the manufacturing and investment elements of the economy.

It’s important to note that Central Banks around the world are not only lowering rates but are intensifying their market intervention by buying assets and extending additional forms of credit to their member banks. In the United States, the repo frenzy Tembo touched upon continues. This signals that there is some leak in the international financial system, some lack of liquidity that needs to be plugged by cheap and rapidly accessible liquid capital. As we’ve noted before, a repo is when the Fed sells a financial product (bond) to big banks only to repurchase them shortly thereafter at a higher price, thus injecting the difference directly into the financial system. This is particularly effective in reducing short term interest rates in the money market.

Canada is in a stronger position than its international counterparts, as our BOC is not stimulating the economy to similar extents, but it is staying cautious and preparing for the worst.

Rate Decision Coming Up This Week

The BOC will be announcing its next move on rates on the week of October 28th. Whether they stay even or go down is a big question, but they most certainly won’t be going up anytime soon.

If rates do go down, expect the recovery and renewed dynamism in the GTA real estate market to be reinforced, and given added momentum. If they stay the same, the higher price and strong demand trends will stay healthy. Most experts predict that the BOC won’t cut rates. The number is low as is and the economic overall is perceived to be in very good shape. While BOC policy generally does not diverge much from the monetary policy of the Fed, many market watchers expect that the Fed’s recent push to lower rates and revive QE (quantitative easing) won’t be necessary in Canada. Unlike the U.S., Canadian politicians rarely criticize or even talk about the BOC at all. At the height of the very high interest rates of the mid 90s, the Bank was politely scolded, and politicians sent letters asking for rate relief. Lately in the U.S., as many of us know, the President is openly at war with Fed Chair Powell; his own appointee. The C.D. Howe Institute, an elite, neoliberal think-tank based on Bay St. is calling for the BOC to hold off on rate cuts now and to wait until early 2020 for cheaper money.

In Washington, the consensus appears to point toward a 3rd consecutive cut in rates by Chair Powell this week. U.S. economic data is weakening, with manufacturing and housing showing slowdowns and the bulk of now much more subdued GDP growth dominated by consumers maxing out their credit cards and increased government spending. The Fed has also quietly began to increase its book of financial assets, and has long since ended its previously strong commitment to incremental reductions of its massive balance sheet. This basically that the Fed is once again buying assets, intervening in the market, and artificially raising asset prices while providing cheap money stimulus to Banks. There is growing repo activity, where the Fed is selling government bonds to investment only to buy them back within days at higher prices – effectively providing the buyers with excess capital that is not loaned. Repo activity is oversubscribed lately and is running the many tens of billions of dollars. This suggests a need for capitalization among U.S. financial organizations. 

As Tembo predicted, the once high GDP growth achieved months ago by a Trump tax cut and low interest rate stimulus is now falling back into traditional territory. If Powell does cut rates again, it will signal that the Fed is both concerned at U.S. economic data and also sensitive to the pressure and open criticism it is facing from a President who refuses to temper his language and who revels in his own bombast. Under Trump, the U.S. federal deficit is climbing again and is now close to the $1 trillion dollar mark. If the U.S. goes into a protracted and deep recession, it will have little wiggle room, little capacity for sustainable government fiscal stimulus, and almost no room to lower rates. A recession anytime soon would likely spell serious political trouble for a President who is staking his political future on a booming stock market, stable economy, and gradual, albeit ephemeral foreign policy retrenchment. 

On the Fed Giving In

As predicted, Fed Chairman Jerome Powell acquiesced to the relentless pressure from the White House and yesterday announced a 25 basis point cut in rates. The constant stream of snipes from Trump’s twitter account finally wore Powell out. His news conference in announcing the cut sent mixed signals and received mixed reviews.

He cited a number of factors which influenced the decision to cut; international risks, low inflation, trade tensions, and weakening growth. He claimed the cut would support U.S. economic expansion and provide extra leverage to the country in trade negotiations. Powell was highlighting an economy at risk and slowing, but simultaneously preaching a favourable long term outlook. Market reaction to the cut was negative. Stocks went down, the dollar dropped, and precious metals rose. 

Some pundits lashed out, claiming the move was unnecessary, politically weak, and that the extra stimulus would overheat stocks. Trump immediately doubled down, furthering his criticism of Powell and suggesting that the Fed should have cut deeper with a clear outline of an even lower  rate trajectory longer term. Another mixed signal from Powell came in the form of his responses to questions about what the Fed would do next. Powell claimed that the cut does not mean interest rates won’t go up again in the near future while also providing vague answers on whether further cuts were on their way. Some pundits believe this cut, or ‘mid cycle adjustment of policy,’ signals an ‘inevitable’ move towards 0% rates, quantitative easing (money printing), and potentially negative rates (where the Fed pays banks to borrow). 

The impact will be felt in Canada soon. Rob Carrick, The Globe and Mail’s Finance Columnist heralded the cut as a positive move which ‘cancelled the apocalypse for overextended borrowers.’ He effectively outlines the case that rates in Canada will now be coming down as well. History has shown that the BOC’s interest rate trajectory takes it cues from the Fed. Governor Poloz has already said the orthodox BOC line, that a Fed cut won’t impact the BOC’s decisions and that Canada doesn’t need lower rates. At the same time though, the BOC has made it clear that it will analyze and keep a close eye on the Fed’s decision and ‘dissect’ the reasons provided for the cut. In the medium term, Powell’s decision will continue to reverberate, and the pressure on easing at home will continue to build.