Back to School, Back to Work - Views from the North

Ben Reitzes:

Welcome to Views from the North, a Canadian Rates and Macro podcast. This week I'm joined by Sam Buckley, head of our Government of Canada Trading Desk. This week's episode is titled Back to School, Back to Work. I'm Ben Reitzes and you're listening to Views from the North. Each episode I'll be joined by members of BMO's FICC, sales, and trading team to bring you perspectives on the Canadian rates market and the macroeconomy. We strive to keep the show as interactive as possible by responding directly to questions submitted by our listeners and clients. We value your feedback, so please don't hesitate to reach out with any topics you'd like to hear about. I can be found on Bloomberg or via email at benjamin.reitzes@bmo.com. That's Benjamin dot R-E-I-T-Z-E-S @bmo.com. Your input is valued and greatly appreciated. Sam, welcome back. It's been a while. Pleasure having you on again. I'm happy you found the time to join me this week.

Sam Buckley:

Thanks a lot, Ben, for having me. It's been a while. I didn't realize it's been a year since the last the patio, rooftop patio restaurant extrapolation we did.

Ben Reitzes:

So I've tried a few times, but you tend to pawn it off on your colleagues right next door to you. But I got you this time because Jeff's not here and I'm going to have Andrew on at some point in the near future, but thanks for coming. I think it's a pretty straightforward time, I think. I'm hopeful you can shed some light on where the bond market is in Canada, dynamics there and we're going to talk about where things are going for the rest of this year. Before we get to that though, the Bank of Canada is next week on September 4th. They make their policy announcement. There is one more big piece of data between now and then, we get GDP on Friday. But honestly that does not matter, I don't think. At least not for next week, unless it is a massive miss or beat and even then I still don't think it probably matters. What do you think the bank does next week? Is there anything that anyone should be looking for that is unexpected, let's say?

Sam Buckley:

No, I don't think so. I mean, I think they're going to cut 25 basis points, which is priced in to a T. I think that the data's been deteriorating pretty consistently for the last, since February, call it more or less. Had a couple surprise up months in inflation there. But by and large the data's been deteriorating for the most part. I mean, I think that the data's going to have to tell the bank not to go or to go 50. So I think that we’re probably on a preset path here for the next three to five meetings of 25 basis points cutting each time. I think the Fed seems to be on that path as well, given the deterioration in their labor market and comments from the Fed. So I don't think there's much to do in terms of pricing on the meetings. I think if you get an outsize print one way or the other in inflation or jobs or even GDP, they could price in 50 or take out a cut maybe. But I think that's what we're doing for the next, call it five meetings.

Ben Reitzes:

Okay. Yeah, I'm mostly with you there. And I guess what's interesting about Canada versus the US or the bank versus the Fed at this point is the Fed comes, gets one more jobs report before they get to decide, whereas the bank doesn't get any more jobs reports. So the bank could go 25 and the Fed could very well go 50 if you get a bad enough labor market report next week. If payrolls are as bad in August as they were in July and you get the unemployment rate up another couple tenths, 50 probably becomes a very real possibility for the Fed, whereas the bank would've already gone 25 and then we'll see what that brings in October for the Bank of Canada. But with the bank already 50 beeps ahead of the Fed, it makes 50s on this side of the border at least a little bit less likely, but I mean, I still can't escape the fact that policy is still quite tight here overall.

We are still well above neutral, everyone's definition of that, be it mine, the banks or anybody else's. And the economy's not in great shape and it's really challenging to rationalize having policy in a net restrictive state at this point. So somewhere down into the threes, at least. The house call is down to 3% by the middle of next year. The risks I think are clearly to the downside there. I think rates probably need to have a two-handle of some way, shape, or form. I'm not sure how low in the twos, but probably twos to get above potential growth going and close the output gap and avoid any of that downside stuff. But we'll see how things play out, how the Fed goes, what the Canadian dollar does, which has been amazingly resilient. I mean, I've been pretty happy about that personally, but surprised as to how strong it's been.

But I think the reality there is just shorts have been clearing out positioning so heavily one way. When things don't go your way for long enough, positioning tends to clean up and that's I think what we're seeing at this point. So I think yeah, as Sam mentioned, pretty straightforward for the bank, data has been one way and I don't know why that changes in the near future. So cuts 25 is the base case at every meeting for a while into 25. Well into 25 let's say, and then we'll see where we are on, you got the US election in the meantime. There's a Canadian election more or less a year from now. That'll be interesting. That could change things a bit. There's also the budget coming up in an election year, which could very well change things for the Canadian outlook. So one thing to mention-

Sam Buckley:

I don't think they'll spend less.

Ben Reitzes:

I think that's a pretty safe assumption.

Sam Buckley:

Don't think they'll spend less.

Ben Reitzes:

Won't spend less. I'm not sure the last time this government spent less. Listeners, you can feel free to let us know when that was. Never. One thing you mentioned is that the meeting gaps are priced to perfection effectively. So 25 beeps in this meeting, 25 beeps the next meeting, 25 beeps the meeting after that. So 75 by the end of this year, not much to do there. How about in the cash market in the Canada market? What are you seeing there? Where are the opportunities? How are we priced? What is the dynamic at the moment? And maybe you could tell us a little bit about summer liquidity as well, if it's been a trying period.

Sam Buckley:

Yeah, I mean, I think that one interesting thing we've seen, we've seen a lot of short covering in the Canadian long end, whether that's cross market on curve. Now I think we're at very interesting crossroads, whereas I don't think anyone's really short anymore. You can see it in the market. We've had a couple provincial long deals, couple corporate long deals, and it definitely feels like the street's a little bit long. We've seen some real money, domestic and international accounts sell into the yield rally and it definitely feels like the street's kind of caught long a little bit here. We do have decent extension on Tuesday after Labor Day, which should provide a little bit of support, but at the same time I think we're going to see a lot of accounts looking to sell into that, whether it's setting up for the September supply or it's really just kind of banking on what we're talking about.

We're at a much lower overnight rate and a steeper curve. I think that the curve has a long way to go still. I call it five spawns and I think that slowly you're going to keep seeing that. You might get these extensions where maybe it doesn't steepen on bad data or it flattens the basis point or two. But definitely the bias is obviously for a steeper curve. And I think that one interesting thing is that we saw a lot of short covering in July, not as much in August. I think it was a lot of it was done other than CAD/US, which over the last month has really kind of collapsed across the curve. I mean I think that when I went away my two week, which was at the end of July, Canada/US 30 year spread was at 110-ish.

When I came back it was 97-ish and call it similar move across the curve, probably more so in the front end. We had the two year auction today two's are really not trading well. I think they traded well for a few weeks in there, but it definitely seems like there's a lot of pressure on them again. I would think that you want wait a little bit, but you probably want to be along a little bit of CAD/US here. I would say in the front end Ben talked about there's a possibility the Fed might go 50, they might, but I do think the bank is on a preset path here, whereas the Fed, I think you might get the odd data pop that might kind of pause them a little bit or derail them. It doesn't seem like everyone is kind of convinced on the plan in the US as they are in Canada.

So I think that might be an opportunity right now that we've seen in the cheapening. And that being said, I do think that you're going to keep getting pressure further the Canada curve, especially if yields stay where they are. If we continue to rally, call it, through 3% in Canadian loan bonds, you're going to get a lot of selling. I mean, even today I think we're at three 15 and the amount of selling that, I haven't seen this much selling that we saw today. It was really, really consistent from a lot of broad based accounts.

Ben Reitzes:

The long end seems to be trading consistently heavy.

Sam Buckley:

Yeah.

Ben Reitzes:

Today was that day, but it seems like it's that way all the time. And I guess the question to ask investors is like, well, why? Is 3% an attractive level? Probably not unless you're in a very low growth, low interest rate world. I mean, we might be to some extent, but inflation probably isn't going away. We're not going back to the 2010s by any means, I don't think. And so 3% seems like a tough pill to swallow.

Sam Buckley:

Yep, I would agree with that and I think that's kind of what we saw today and what we're going to see. I also think that, I mean, a lot of people are talking about issuance being front-end loaded in front of the election. I mean, we've had a lot of issuance this summer. I would say an abnormal amount of issuance, but I still think that issuers are looking to get ahead of the election. So I don't think September will be quiet by any stretch on that front. And it felt like today that people were kind of using the rally that we've had to unload on some duration, especially along and maybe in front of to make room for supply in September.

Ben Reitzes:

The election is a good point, I guess. Through the summer, couple months here, July, August, I mean, usually going into those months you expect supply to slow down and it really hasn't at all. So I guess companies and provinces just getting ahead of that November, I guess window that's expected to potentially close. I guess the positive one way to look at that would be that if you don't get any kind of disruption through that election period, spreads could actually come in pretty sharply. On the provincial side in particular, they just really have been stuck here, stuck in the mud to some extent. And part of that's because issuance kept going, it has not stopped, but they're so far ahead of pace that things could look pretty good assuming you don't get any kind of disorderly outcome around the election, which I don't think is the base case, but I really don't think anybody knows either.

Sam Buckley:

I don't think we know. I think there's a lot of uncertainty around that. A lot more than there was six weeks ago or however long ago that was.

Ben Reitzes:

Yeah, I guess it's fully up in the air, but we'll see how the next, what, two months of information coming out of the US drives the electorate there. It will certainly be interesting. Curve steepening, how far can we go? So 10s, 30s is been hovering just below 10 basis points for a while now. Does that keep going? Does it get to historical norms, past cycles? And I guess to some extent when you're looking at past cycles, you almost have to go kind of pre-financial crisis, because the past 10 years may not be consistent with the current environment and maybe shouldn't be used, which makes things a bit of a challenge.

Sam Buckley:

Yeah, I mean, you mentioned it, I mean, 3% for 30-year money. I'm not sure if that's what it gets accounts excited these days with the worry that inflation might creep back up again. So I think that it has the potential to go even steeper than we've had in the normal past cycles if we get down to kind of the mid to low twos on the overnight rate. But again, that's dependent on issuance, it's dependent on outright yield levels and that's obviously dependent on what the Fed does as well. So I think there's a lot of uncertainty around that, but I don't think that it's going flatter. I don't think five spots is going flatter.

Ben Reitzes:

How about fives on the curve though like two size 10s? Because I think that's far more challenging given the flows that don't seem to be completely ebbing just yet. That's continuing. And so that part of the curve continues to be supported and I don't really know when, I still don't know when that changes. And I've been saying it for a number of weeks if not months now that I don't know what's going to drive five-year mortgage originations to really pick up and stop that flow because we're, I don't know, in my mind still at least 50 basis points and five away, maybe a little less than that, but at least we might be more than that because I don't know if mortgage rates will be that reactive to where the market is.

Sam Buckley:

And if activity will be that reactive.

Ben Reitzes:

And that is probably the better point is buyers are going to be pretty cautious for a while I suspect, especially in the Toronto, Vancouver condo markets, those are very well supplied to put it kindly and so are under a meaningful amount of pressure and so there's no rush to buy on that front. And there's plenty of houses trading at well below what their ask is, and I don't know why that's going to change I guess unless mortgage rates again, they have to really come down, but is 4% low enough to spark a lot of activity? I'm not even so sure about that. And that's I guess where the really big uncertainty is, is where do you get that traction in the housing market? And it could be a ways down from here, which is part of why I think that there might be a lot more downside for the bank Canada on rates.

Sam Buckley:

Yeah, and I mean, I think we've talked about it too. How's the economy doing? Do people feel confident enough to go buy a house, to go upgrade their house? I think there's a lot of uncertainty around that. I would actually say that I think probably being short fives on the curve might be one of the more crowded trades in Canada, if not the most crowded trade. After all, the long bond short covering was out of the way. I'd say that's probably the most crowded trade. So if anything, I think that it probably has the potential to be exacerbated if any short covering needs to happen.

Ben Reitzes:

That'll turbo steepen the curve as well. Yeah, interesting. Okay. I guess we've seen a decent amount of that. I didn't really put two and two together there.

Sam Buckley:

I would say that this summer compared to especially last summer and prior summers, it's been more orderly in terms of liquidity. I think that the market's been fairly stable in terms of on the liquidity front, nothing's really gotten too out of whack from an RV perspective. So I think that's probably a win, I would say for the market. But we'll see what September brings.

Ben Reitzes:

Well how about the rest of the year? The rest of the year so you're expecting issuance to continue through September and probably October depending on when election jitters begin. I'd say at least midway through October. So that should keep some pressure. I assume further at the curve on the long end. The corporate side, maybe it's right across the curve related across the curve.

Sam Buckley:

It's probably the, the corporates.

Ben Reitzes:

Sub-tenure most of the time.

Sam Buckley:

Keep pressure on cash versus futures, keep bases elevated, kind of consistent what we've seen over the last little while.

Ben Reitzes:

Keep funding costs elevated as well.

Sam Buckley:

Keep funding costs elevated as well. So I think that some of those small micro RV things will continue to be present in the market.

Ben Reitzes:

Okay. So more issuance, steeper curve. I guess from a bigger, but that's just more the same at the end of the day.

Sam Buckley:

Yeah that's more the same. I mean, until we start getting, if we get an uptick in the data or an improvement, then I don't see any real reason for it to change. And like you said, you're not sure for a reason for the data to change.

Ben Reitzes:

I don't see one, at least not near term. It's pretty challenging to see what's going to drive better growth. It's not as if there are any catalysts waiting on the horizon. if anything given that population growth is probably poised to slow, maybe really sharply. I have no idea when, but they're taking a sharp look at it and things could just grind to a halt in an awful hurry. That's a clear downside risk for the growth outlook. I mean, it helps per capita growth, which arguably matters more for people here on the ground and how we feel about the economy.

But it's going to hurt the headline numbers. It's going to make everything look materially worse. And on the bright side, I guess at least it helps on the housing front maybe. Not necessarily less pressure, but not more pressure either. So we'll see how that evolves. So yeah, it is a challenging outlook I think. And again, yeah, you're right. I don't see how that changes through the rest of this year. And then on top of that, add the US election uncertainty and if you get Trump coming in and putting tariffs on Canada across the board or on everybody including Canada, that is going to be very bad for Canada.

Sam Buckley:

Yes, yeah. One interesting thing about the election, I mean I think a lot of people have this Trump steepener trade on. And I think, I don't know if necessarily if the Republicans get in, if they sweep, if that's necessarily more of a steeper curve or more higher rates than if the Democrats got in and they swept as well. I don't really think that there's much of a difference that both they're going to spend a lot. If anything, Trump might be more inflationary, so that might put some restrictiveness to what the Fed can actually do. So I think there's a lot left to be seen here and I think there's a lot of uncertainty around the election.

Ben Reitzes:

That's fair. I don't think we really know what they're going to end up getting at the end of the day and I'd kind of be surprised if there's a sweep, personally. Whichever way I vote, I'll probably vote the other way for Senate and House, I do get to vote, I'm also American and I don't know which way I'm voting yet, just to make it extra fun. Not that I'm going to tell anybody anyways, the last thing I need is for people to be berating me for my terrible vote. There's two bad choices, so I think I can just leave it at that for now.

Sam Buckley:

And I haven't forgotten our bet that we made a year ago too on the Canadian election. I think the incumbent government might make things a little bit more interesting.

Ben Reitzes:

We'll see. We will see on that. Favorite trades before we wrap up.

Sam Buckley:

Long Canada/US, anywhere on the curve and steeper in Canada, five bonds.

Ben Reitzes:

Long Canada/US even in longs at 95-ish.

Sam Buckley:

I think for now.

Ben Reitzes:

Okay. Just into month end or was that going to-

Sam Buckley:

Yeah, just into month end into the bank.

Ben Reitzes:

Okay.

Sam Buckley:

All right.

Ben Reitzes:

I like that, very front end. So U5 is like 30 basis points through to 32 I think I saw this morning and that just doesn't seem right to me.

Sam Buckley:

Yeah, I'd rather the front end of the curve.

Ben Reitzes:

Okay, all right. We're aligned there and definitely steeper for sure. I still like long US 10s, short Canada longs as a bigger macro trade that you can just keep on and go to sleep-

Sam Buckley:

That's done well.

Ben Reitzes:

And feel good about yourself. That's going to keep doing well. There's still plenty to go. The fed's still got to cut. They haven't even started yet, so there's still lots to go on that front. Sam, thanks for coming on.

Sam Buckley:

Thanks for having me, Ben.

Ben Reitzes:

And I hope everybody had a nice summer and we'll be back to you in a couple of weeks. Thanks for listening to Views from the North, a Canadian rates and macro podcast. I hope you'll join me again for another episode.

Speaker 3:

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