Not So Fast - Views from the North

Ben Reitzes:

Welcome to Views From the North, a Canadian Rates and Macro Podcast. This week, I'm joined by Joel Prussky, our cross currency and OIS trader. This episode is titled Not So Fast. I'm Ben Reitzes and you're listening to Views From the North. Each episode, I'll be joined by members of BMO's FIC sales and trading team to bring you perspectives on the Canadian rates market and the macro economy. 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.R-E-I-T-Z-E-S-@bmo.com. Your input is valued and greatly appreciated.

Hi, Joel. Welcome to 2024. You're the first guest I'm having this year, and I don't want to admit it to you to your face, but I enjoy having you on. Makes me happy.

Joel Prussky:

You literally just admitted it to my face.

Ben Reitzes:

I said I don't want to, but I am.

Joel Prussky:

You did. Well, thank you, Ben. I will say that this is the best podcast I've ever been a guest of as well.

Ben Reitzes:

Because it's the only podcast you've ever been a guest of. See, this is why I don't like to tell you things, but that's the way life goes. 2024, setting up to be an interesting year. Busy week this week so far. We're recording a bit early this week. It's Tuesday instead of Wednesday. We got CPI this morning, Business Outlook Survey yesterday, the Bank of Canada's next week. There was a pretty aggressive rally and rates into year-end, and now it's going the other way.

Why don't we start with the bank? I think it's pretty straightforward at this point, but what are your thoughts on next week, and maybe when do you think they could start cutting?

Joel Prussky:

Well, I think next week's should be a pretty much hem on rye meeting. Rates aren't going to change. I think the bank has enough evidence to say that time is not right yet to cut rates. I think growth is slowing. I think anecdotally, people probably went nuts over Christmas and did their last hurrah spending-wise, and I think January's a retracement time anyways, so empty stores aren't indicative of anything, but I think growth is slowing, inflation is heading in the right direction, maybe not as fast as the bank would like.

I think that they will be hesitant to give the market too much, given that we already have so much rate cuts priced in. I think before the CPI today, we had over a hundred by September, and I think we're just under a hundred by September. My guess is it's pretty much the old two-handed economist stuff, right? This is good. This isn't so good. Rates are broadly appropriate for now.

That being said, I do think there has been progress in the inflation front, and that rates at 5% are probably a little too restrictive, and that at some point, rates should, I think, come down to be slightly less restrictive, because of the gains that we've had in inflation. The problem is, it's an impossible message for the Bank of Canada to get out there. Whatever they do will be acted upon. It'll be, "Oh, I see you're 50, I raised you 150." I think because of that, they'll be hesitant to give the market too much.

I think they should probably be starting to cut rates in March or April, myself, like a quarter point. The problem is, again, with the messaging. The market will say, "Oh, my god, they're starting." Most of the guys in the market are too young to really know what average rates were over a real point of time, and they'll immediately think, "Well, next stop 2%." I'm not sure we'll see 2% in my career again in overnight rates.

Ben Reitzes:

I agree generally, when they start cutting, I guess, yeah, we will get a big rally. I think we'll go way too far, way too fast. I believe pretty strongly that'll be a selling opportunity at the time whenever that comes, whether that's whatever, one cut, two cut, three cuts in, at some point in that cycle, you're going to get a very good selling opportunity.

What I thought you said was maybe a little more interesting was, it really, for me, it struck the difference between the bank and the Fed, whereas the Fed is really focused on where real policy rates are and not being overly restrictive, whereas the bank doesn't really have that luxury, it seems, because they're so focused on inflation and hitting their inflation target.

If they're not at least on their way or very close to that point, it's hard for the Bank of Canada to message that they're allowed to be cutting rates or that they should be cutting rates. Whereas the Fed's like, "Well, we know we're moving in the right direction. We don't want the economy to get too weak, so we're going to cut whatever. If it's a hundred, and bring real policy rates from, I don't know, plus 250 to 150, and we think that's still restrictive, and that enables us to cut," whereas the bank doesn't, at least not yet.

They haven't provided that messaging yet. I think it's going to be hard for them to do that, and especially because in the Business Outlook Survey and the Consumer Survey, inflation expectations are still pretty high. They barely moved down on the consumer side, and they did not move down on the business side.

Their almost number one job still is to contain inflation expectations to keep inflation coming down, because if they don't, everyone's going to want 3, 4, 5, 6, 7% wage growth in perpetuity, and that's not 2% inflation.

Joel Prussky:

There's two things I'll say to that, about that. I guess the first thing is the bank has talked about not wanting to over-tighten. They have talked about that concept. Now, what that means in practice, I don't really know, and we haven't really heard from them in a long time. There are growth numbers that continue to show weakness, and they're going to have to answer for. I agree that they haven't said that yet. I don't know that it's not forthcoming soon.

Ben Reitzes:

They could change. They could change, admittedly, but they haven't yet.

Joel Prussky:

They haven't yet, but yet we haven't heard from the bank. I guess my point is we haven't heard from the bank in a long time. We have to come and hear what he says next week, and he's going to answer questions. There's going to be questions asked about things like that. There is obviously a slowing going on in the economy. The other thing is, the central banks of the world are high-fiving themselves because they've managed to lower the rate of increase of prices.

This is a derivative, not an actual lowering of prices, and people are still pissed off when they go to the grocery store, still pissed off when they're trying to buy something that costs a lot more than it used to. I think that's a challenge that I don't know how other central banks ever get around, because people say, "The central bank's going to high-five themselves when they get to two," and the guy's going to say, "Grocery bill went from 180 to 300 bucks, and why you guys think you're doing such a good job?"

Now, they're still going to be happier with lower rates, but how we manage to live with overall higher prices and not want wage growth to continue is going to be a problem. People do deserve real wage gains.

Ben Reitzes:

There's an answer there. The answer is it's not that easy one, but the way out is kind of an extended period of reasonable inflation with some productivity gains to give you real wage growth, over a multi-year period. You do get some catch-up there and you don't really see, it's kind of like the past, the prior 10 plus years or so, where there was really no inflation.

You couldn't see the inflation. It was there a little bit, but you could see it. Not day to day, that's for sure. Not week to week, and not month to month-

Joel Prussky:

Was that off productivity, or was that off just such a low inflation rate of 2% is noise-ish for most people?

Ben Reitzes:

Yes, that mostly, that inflation is so low that you don't really realize it, and there was some productivity gains. It was there, not great, but it was there. You did get some incremental improvement. We need to return to that, and that's the answer. I think that's what they're striving for. Good luck.

Joel Prussky:

Canada can't do anything about the productivity case.

Ben Reitzes:

No, they cannot. Unfortunately not. I don't really see how that improves in Canada. This is a totally other conversation, but it's hard to see Canada getting out of this productivity funk at all. If you think about what drives productivity, you have to incent people to want to work harder, to want to work better, to want to work smarter, to want to work more efficiently. There's a few ways of doing that.

One investment's a way to do that. On the production side of things, you buy machines that make things more efficiently, you need less people. Productivity goes up, sure. Do we only produce stuff? Definitely not. There's a whole other side of this. For people in general, it's like the technology side does matter a lot. Is Canada a tech hub of the world? Not even close. Why is that? What...

Joel Prussky:

I thought we had a pretty good tech industry. How about getting our Federal-

Ben Reitzes:

When was the last time you heard about that? What year was it?

Joel Prussky:

We have Mars here, which does some amazing thing. I know Google hires a ton of people.

Ben Reitzes:

Where's Google?

Joel Prussky:

Well, we're their headquarter, but they hire a lot of Canadian programmers.

Ben Reitzes:

I understand that.

Joel Prussky:

How about getting the federal government to actually not be anti-oil and gas, a commodity that at some point in the future, whether it's 10 or 50 years, no one will have a demand for in theory? How about saying, "Let's sell what we have now while people care about it, and there's high prices for it?

Ben Reitzes:

Yeah, but it's more than that. Allowing the companies to operate in a way that they can develop their intellectual property, that you can sell to other oil and gas producers in the world to make things more efficient, be it on the carbon side or not, it doesn't really matter. Stuff like that, and just incent good people, smart people, people that are highly productive to want to come and stay in this country, instead of taxing them to death would be kind of my, that's...

Joel Prussky:

I'm all for that. For sure.

Ben Reitzes:

Personally, that's my bias, obviously. If you can choose, if you're a, it doesn't really matter where you're from, honestly, you could be from Canada. It doesn't make a difference. If you don't necessarily have family ties to keep you in one place and you can get a similar job in Canada, the US, the lifestyle you're going to get in the US, especially given the inflation costs over the past couple of years, and the housing troubles in Canada, you just get a better lifestyle in the US to some extent.

I know that's debatable, and I'm sure I'll get tons of people yelling at me, but that's how I see things. Now, given what I see from the people that I know that have moved to the US, not recently, but like 10, 15, 20 years ago, for those in the higher income bracket, it can be a better lifestyle.

Joel Prussky:

Well, yeah, I think the tax rates are egregious in Canada. I think everyone will agree to that. At least the people who pay the taxes will agree to that.

Ben Reitzes:

Actually, so it's not the rate actually that's so bad. The thresholds in which they kick in...

Joel Prussky:

I think you're right.

Ben Reitzes:

The rate's not great.

Joel Prussky:

I think anytime a marginal tax is about 50%, it's criminally irresponsible.

Ben Reitzes:

I agree.

Joel Prussky:

That aside, I also think there's a breakdown of the social contract going on right now. Part of the social contract in Canada was that it's a safe place to live, and you have healthcare, and accessible to healthcare. I think that the federal or provincial, whoever you want to blame and finger point, are failing on the healthcare side badly. Whether Canada's a safe place to live, arguably it's a lot less safe than it was a year or 10, whatever, five years ago.

To me, that breakdown with social contract, it's not just happening here, it's happening in the UK as well, other places. Once that happens I think they start to lose control. What that looks like ultimately is you talk about upper income people, they're going to leave. They're going to say, "You know what? Maybe I could live with 20% less tax rates somewhere else, and I'll pay for my own hip replacement, and I won't have to wait two and a half years for it," because that's not the government doing their part of the bargain.

Ben Reitzes:

We've gone way off course here.

Joel Prussky:

We have gone way off.

Ben Reitzes:

Let's go back here to the bank. When do you think they cut?

Joel Prussky:

I think April's probably not unreasonable. If they continue to see growth slowing, and as you so astutely pointed out today, CPIX is actually heading in the right direction. If they only had not introduced the 17 other measures of inflation, they could have point to some success, and they could maybe start going.

Again, I think the messaging's going to get very hard for them to... How to start going and not have the market get too much out of control. Let's say, I think April. I think...

Ben Reitzes:

Is April contingent on the Fed going first?

Joel Prussky:

No, I don't think so.

Ben Reitzes:

Okay. Do you think-

Joel Prussky:

I like to believe that that's not the case. Unless the Canadian dollar was at 1.45, I don't know why the Bank of Canada should care what the Fed does and when.

Ben Reitzes:

I guess so April, just mostly then on the economy rather than inflation, because the inflation, the metrics that you're not getting to where I think you need to be by April. It was hard before. Now, it's like, you need negatives at some point in the next few months to get to where you need to be on a year-over-year basis, and in the shorter-term metrics to get where the bank will be comfortable cutting, because we're miles from there now.

Joel Prussky:

I guess it also depends, the bank we know is model-driven, so it also depends on some of the other data. If you start to see retail sales fall off a cliff, if you see some of these other things, they know that over time, that will kick in. They can't afford to let the economy go into a deep, deep recession. I think they're political. I know everyone says central banks are not political. I think that's a bunch of crap.

I think they're all political at the margin, and if you start to see that, I think they'll have some comfort that they can take rates from. Taking rates from five to four, I think, is still restrictive.

Ben Reitzes:

Yeah, it is. Deep recessions, things need to start unraveling.

Joel Prussky:

They need to be-

Ben Reitzes:

... Worse than they already are.

Joel Prussky:

They need to be comfortable. That's the path they're going down if they keep rates at 5%, yeah.

Ben Reitzes:

Okay, that's fair. I won't dispute that point.

Joel Prussky:

I think March is too soon. Remember, it's very hard to determine what the real percentages are, because CORRA's so polluted right now, right? CORRA's coming in at five beeps over target. When you look at where things are trading, you think, "Oh, they're pricing in this percentage."

Well, they're pricing that and a normalization of CORRA. Things are getting a little bit wonky. It gets a little bit hard but arguably, even after today's sell-off, April is almost fully priced for a full 25 beeps cut, given where CORRA's been setting.

Ben Reitzes:

Monthly GDP has been pretty much flat for most of 2023. November's looking, I kind of get about zero, it depends on how much weight you want to put on hours work, but it doesn't look like things are great by any means to end the year. You're saying it has to get worse. I'm not convinced things are going to get that much worse. I think incrementally, we continue to get the hit on the mortgage front, but I don't know if things deteriorate further from where we are.

That's where I'm kind of torn on when they might be easing. I think I'm a little bit more focused on the US right now, in that if the US hangs in there, I don't know why Canada's going to weaken even more than we already have. It's just we kind of meander sideways around zero growth for a little bit longer. Whereas if the US falls off the cliff, they weaken a lot, and you get some negatives there or some zeros on GDP, then Canada probably looks a lot worse.

I think we get that that, that'll be the story over the next kind of three to six months or so. We'll know how much of an impact the rate hikes in the US have had on the US economy at the end of the day versus kind of where we are now, where things have been surprisingly resilient, I guess, to say the least. Maybe that's driven by fiscal policy entirely. We'll wait and see, but that's what I'm more focused on. One of the narratives that I'm keen on at least discussing is like, okay, well, the US, the Fed has raised rates 525 basis points.

The US economy, let's say, let's live in a world in which you know what? It doesn't weaken off that much. Inflation continues to fall off, but the economy-

Joel Prussky:

Two and a half percent growth.

Ben Reitzes:

... Hangs in there, whatever, one to two and a half percent. It doesn't even have to be that strong. Inflation continues to trickle down at least for a little bit. The fed unit says, "You know what? We don't need rates to be this tight on net, and we're going to cut a hundred basis points over the course of this year." 2025 comes, and guess what? Well, those rate cuts have re-sparked growth a little bit.

You go back to two and a half percent growth or higher, maybe three, three and a half percent growth, who knows? Inflation picks up again, and rates have to go higher again. I can see that happening pretty easily, and the market would get just sideswiped pretty badly on that.

Joel Prussky:

Sure. They'll have things like two year, one year, three year, one year, two and a quarter...

Ben Reitzes:

Well, that's kind of-

Joel Prussky:

... After the big rally, and it'll be clearly, that two and a quarter is an emergency level of funds from now on, not zero. I think that whole psychology takes a long time to play out.

Ben Reitzes:

Yeah, this is-

Joel Prussky:

That's almost, it'll take a generation for the market to understand that that's not how it's going to be, and part of that will change, I think, if the long end continues to have lack of sponsorship, and you really steepen the curves out, then you're not going to see those forwards as deep discounted as you are.

You'll have things like tens bonds in Canada will be plus 80, and Canada US won't be minus 102, it'll be flat, or whatever, or minus 30. As a much deeper curve comes, the forwards won't look as silly. Part of the reason why the forwards can look as silly is because we have such a flat curve in Canada.

Ben Reitzes:

You're saying you don't think that the curve's going to stay as flat as it is in the long end, is going to sell off maybe materially from here.

Joel Prussky:

I don't know why anyone would buy a long bond, ever. I've been saying that since they were at three quarters of a percent. I still think at the current yields, you're not offered enough inflation protection. I get it, there's investment counselors who have money to spend, and they don't really care the price. I get all that stuff, but I think you saw what happened in the UK when things get out of control on the fiscal side, and they can't rein it in, and people do silly things.

I think that was the canary in the coal mine. I think you have to be cognizant that that could easily happen very quickly. I think we're going to a multipolar world. I think the US dollar is eh, whatever. I think Donald Trump wins, it gets even worse, because he doesn't want to engage with the rest of the world. He prefers in America first, and that's fine. I think you want to vote him in and that's what you want out of your country, that's great, but there is an exorbitant privilege that goes with being the currency of the world.

You are already in the press of losing that. I think an election by the Republicans will probably speed that up a little bit, and I think that will mean higher yields in the long end. I think that will absolutely spill over to Canada. I think we're due for steeper curves. Absolutely. There's too much debt out there. Who's going to buy your debt? Saudis aren't going to buy it, the Chinese aren't going to buy it. The Russians aren't going to buy it.

You just confiscated all this Russian money that you claim you're going to give to the Ukraine, for example. Why would any foreign entity buy US dollar denominated debt when it can be taken away from them at any time?

Ben Reitzes:

Is this a 2024 story?

Joel Prussky:

No, but who cares?

Ben Reitzes:

I care. Pretty sure everybody cares what you're... Matters.

Joel Prussky:

I guess. If you want a Big Mac review, it doesn't mean you can't make money being long, long bonds and they could rally 30 beeps, but the next 200 basis points in long bonds is higher in yield, not lower, I think.

Ben Reitzes:

I'll buy that. That's fair. That's reasonable. Near term, I'm kind non-constructive today, but I think we sell off another 10 basis points and things look a little bit better.

Joel Prussky:

Could be.

Ben Reitzes:

Just kind of short term.

Joel Prussky:

I just think at a hundred beeps through the US, I'm like, "Why would I bother?"

Ben Reitzes:

Yes.

Joel Prussky:

There's just not enough yield compensation, and we have such a flat curve. I'm like, "Why?"

Ben Reitzes:

Yes, Canada, US and Canada, tens thirties should...

Joel Prussky:

Those kind of trades.

Ben Reitzes:

We should cheapen, definitely. That's pretty clear. All right, Joel, that was a pretty good start to the year here. Pretty compelling conversation. Hopefully, I didn't get myself into too much trouble.

Joel Prussky:

We never talked about any of my Jordans.

Ben Reitzes:

We're going to leave your Jordans aside. We got into taxes and social stuff, and we probably should be doing ….

Joel Prussky:

I got a new pair, Benny. I should have worn them today for you.

Ben Reitzes:

Next time.

Joel Prussky:

They're beautiful.

Ben Reitzes:

I look forward-

Joel Prussky:

Gray with orange print on them.

Ben Reitzes:

Next time. I look forward to seeing your beautiful shoe collection one day. Trade ideas. What do you got to start the year?

Joel Prussky:

Well, in the very front end, like OIS stuff, I honestly don't see a lot of great value. Some of those meeting switches got to more than minus 25 the other day. I think if you've been in the flattener of money market flatters, I don't know why after minus 25, you'd be hanging around. It's time to take them off. I think one year, T-bills are super cheap to the first couple meetings. That's a trade we wound up putting on today.

I don't see a ton of great trades, because I think all it takes is one crucial piece of data, and the entire complex in the front end could change. One really weak number and all of a sudden, boom, they don't care what the bank may have said three weeks ago or five weeks ago at their last meeting. Here's something that... A big piece of information. In the cross currency space, that thing is as thin and as illiquid as ever. You've got a lot of dealers out there who are very myopic and they're risk taking, so they don't really spend a lot of time looking at the curve.

All they care about is, "I'm in this sector, I need to get out of this sector." We have a lot of micro trades that historically have paid off well, and sometimes, you have to wait and wait until some come up, but we're back, the curve's getting pushed around again and silly. There's a lot of good little single and doubles out there. Things like four year, two year, eight year, two year for example, or for ten year, two year, I love right now, that's kind of my favorite trade at the moment. There's also a lot of other little micro trades.

If anyone's listening is interested, just reach out to me on Bloomberg, and we'll put a few of them in front of you. I think that's an ongoing, I think those opportunities are going to be ongoing, because I think we live in a world where we're really hemmed in by regulation. I also think we have a generation of guys who've taught that no risk is the right risk, and that's perfectly fine. We love them for that, but that doesn't mean that there's a difference between no risk and smart risk. We like to be on the right side of that equation.

Ben Reitzes:

Okay. Why don't we leave it there? Thanks for coming on Joel, and I will most definitely have you on again relatively soon.

Joel Prussky:

Thanks, Benny.

Ben Reitzes:

Pleasure, everybody.

Joel Prussky:

Bye.

Ben Reitzes:

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:

The views expressed here are those of the participants and not those of BMO Capital Markets, its affiliates, or subsidiaries. For full legal disclosure, visit bmocm.com/macrohorizons/legal.