What to Expect from the Bank of Canada Meeting — March 10, 2021

Forget everything else and keep an eye on the 5-year bond yield. Okay, maybe, not everything considering the stock market has taken another March plunge. Nevertheless, we should pay attention to the 5-year bond yield as this happens to be the maturity that largely determines the direction of mortgage rates in Canada. When this rate goes up, mortgage rates are bound to follow and vice versa.

Why bother: Well, both the GoC and US yield curves have steepened in the past three months and this surge in the long end of the curves can primarily be explained by what is happening down south of the border where there is a growing consensus belief that U.S inflationary pressures will rise more quickly than previously expected. This is heightened by the fact that the economy seems to be roaring back to pre-pandemic levels at a rapid pace coupled with another large stimulus package ($1.9trillion dollars has just been approved by the Senate).

Investors were also left underwhelmed by the Fed Chair’s comment to the Wall street Journal last week, where he dismissed inflationary fears and yet provided no indication on how (or if) the Fed would address the ongoing rout in the bond market.

While the same inflationary concerns linger here in Canada, many analysts, however, believe the current surge in the domestic bond market is more of a FOMO effect and the GoC yield curve is just piggybacking on what is happening to the US yield curve.

Canada Economy Picking up? Residential home sales are surging again. In Calgary, home resales rose the most (54% y/y) in almost 12 years in February and closed in on the strong levels that prevailed in 2014 just before oil prices crashed and the provincial economy plunged into recession. Similar developments have taken place in Edmonton — where resales soared 52% y/y and aggregate prices increased 3.9% in February. Overall, the housing market has been on such as tear that it prompted the CEO of Canada Mortgage and Housing Corporation, to acknowledge that his organization’s prediction of plunging home prices in 2020 was wrong –not surprised they got it wrong.

Other Key Considerations:

· Annualized GDP growth rate for Q4, 2020, closed out at 9.6 percent, exceeding the consensus estimate of 7.1%.

· International trade balance jumped into a surplus in January, showing $1.5bn surplus vs. a $2bn deficit in December.

· Inflation rate rose to 1 percent in January 2021 from 0.7 percent in December 2020,

· While unemployment rate increased to 9.4 percent in January 2021 from 8.8 percent in December 2020 as the economy shed 213k jobs during the month, which was well above market forecast of 47.5k.

This better-than-expected economic growth has raised fresh questions about how Canada’s top economic policymakers will respond, particularly in light of the Bank of Canada’s own forecast in January that GDP would shrink 2.9 per cent in the first quarter of this year. This forecast now seems unlikely- not surprised they also get things wrong, as many analysts now predicts another strong economic showing in Q1, 2021.

Alberta’s Economy:

Alberta unveiled its provincial budget which shows a projected deficit of $18.2bn for FY2021–22. Key takeaways of the budget include:

· The deficit for FY2021–22 is expected at $18.2bn or 5.3 percent of GDP. This is $2.7bn bigger than projected in the November fiscal update and is a result of an increase in spending.

· The deficit is expected to shrink in the coming years but remains sizeable at $11bn in FY2022–23 and $8bn in FY2023–24. As a result, the province’s debt level is expected to continue to rise, reaching 26 percent of GDP in FY2023–24 from 20 percent of GDP currently.

· Consequently, it is believed that the cost of servicing the debt will represent about 7 percent of the government’s revenues by FY2023–24.

What to Expect Tomorrow:

I would suggest we dust off our ECON 102 — Introduction to Macroeconomics notes as I believe a refresher on the understanding of the relationship between interest rates and inflation rates will be important in the coming months. There has been growing critics in some quarters that governments around the world have poured in too much money to support the economy during the pandemic. The robust fiscal support coupled with prospect of earlier than expected inoculation of the population appears to have boosted potential consumer spending rather significantly. There is now grave concern that this additional spending could fuel inflation well beyond undesirable levels and the Bank of Canada (BoC) might be left with no choice other than to raise interest rates to rein-in inflationary threats.

Though the apex bank is dialing back some of its own monetary support programs, the Federal Government on the other hand has just announced a 12-week extension to the Canada Emergency Wage Subsidy (CEWS) and the Canada Emergency Rent Subsidy (CERS) and there is plan for another fiscal stimulus package valued at C$100 billion which is expected to be rolled out over the next three years.

While, we do not think the BoC will increase interest rates tomorrow, however, the odds for a rate hike has increased significantly in comparison to where those odds stood as at December 2020 (in fact the odds back then were in favor of a rate cut). Paraphrasing in the lingo of the popular reddit group — wall-street-bets, “it appears the odds for a rate hike is now #off-to-the-moon”.