December BoC Preview: Heads, We're Slowing Now. Tails, We're Slowing Soon.
By: Andrew Kelvin, Robert Both, Chris Whelan, Mazen Issa
December 5, 2022 - 6 minutes
We look for a 25bp rate hike at the December BoC meeting, with the statement signaling further rate hikes to come. That said, the announcement feels exceptionally uncertain, a fitting end to a year that has been full of surprises. The Bank of Canada shifted to a more balanced communications strategy over the last month, in stark contrast to the fire and brimstone inflation-fighting bluster of the summer and early fall. Governor Macklem has acknowledged that the Bank is getting closer to the end of its tightening cycle, which implies a slower pace of hikes at some point in the next few meetings. The market is pricing this as something close to a coin toss, the analyst community is divided, and we wouldn't be surprised by either a 25 or 50bp move. We look at the arguments for both.
Arguments for 25bps
- A substantial amount of tightening is already in the system. Debt sensitivity is the most important factor underpinning the growth outlook in our view, particularly given potential non-linearities in the transmission of monetary policy. We think it would be prudent to proceed more cautiously going forward.
- Ex-food and energy CPI is showing signs of deceleration. The seasonally adjusted ex-food & energy measure printed at +0.2% m/m in October, its slowest pace since November 2021, and the 3m trend is at its lowest level since January 2022. Similarly, measures of input prices, shipping costs, and expected output prices are all showing signs of moderation.
- Fiscal stimulus won't get in the way. We do not expect the federal government to get in the BoC's way in 2023. The 2022 Fiscal update included only minor increases in spending and instead focused on the improving picture for federal finances.
- BoC seeking balance. Recent comments from the Bank of Canada suggest a degree of apprehension around the pace of tightening. Governor Macklem opened the door to slowing the pace of tightening following the October BoC announcement and acknowledged that the BoC was getting close to the end of its tightening cycle.
Arguments for 50bps
- Core inflation remains too high. While the BoC is no doubt relieved to see that headline inflation has probably peaked, core inflation metrics remain worryingly high. Both the weighted median and trimmed mean metrics rose by 0.1 p.p. in October, to 4.8% and 5.3% y/y, respectively.
- Less slack in the system than previously estimated. The October jobs report points to a more robust starting point for the labour market and in turn argues that it will take incrementally longer for labour market slack to emerge. Similarly, the upward revisions to GDP from 2020-2022 and 1.4 p.p. upside surprise in Q3 real GDP also argue for a starting point with less slack.
- Wage pressures have yet to slow. Wage growth for permanent employees has been stable over the last six months at roughly 5.5%, which further speaks to a tight labour market and represents an upward risk to future inflation pressures.
- Global central bank trends. The ECB, BoE, Fed, and RBNZ all lifted rates by 75 bps at last meetings, are all expected to hike by at least 50bps next time. While the BoC will obviously be more sensitive to domestic developments than international trends, the path of least resistance is often to follow the global trend.
We see merit in both sets of arguments, but ultimately, we lean towards the idea that a slower pace of tightening makes sense. If Canada is in fact within 50-75bps of terminal, the BoC can afford to revert to a more finely tuned approach to monetary policy in order to avoid an overshoot. If it turns out that a terminal rate of 4.75% or 5.00% is more appropriate, the Bank can keep lifting rates by 25bps into Q2. The path to the terminal rate from here is less important than determining the actual terminal rate.
FX Strategy
November was a month to remember. Coming into it, we had a bias for broad-based CAD underperformance on crosses with short CADJPY and long AUDCAD, which has played out much faster than we expected. Indeed, the CAD has been particularly dragged by weakness in the broad USD. The latter is enduring one of the most significant and rarest positioning squeezes in decades. But with Powell expressing more concern and uncertainty recently, calls for a higher terminal rate by him and the rest of the FOMC seem to not carry much weight. Moreover, November saw a significant correlation switch: the USD is showing as much if not more sensitivity to easing priced into the curve rather than just the tightening portion as it was at the start of autumn period.
That leaves USDCAD likely anchored lower for now. But we iterate that the CAD is one of the currencies we are most bearish on into 2023. With the BOC signaling that the tightening cycle is nearing an end or at a minimum, not likely to be as aggressive, focus will shift to the idiosyncratic factors that we have long warned about, especially as the Fed also downshifts. The debt binge that has supported the Canadian expansions in the past thanks to an era of low interest rates is over.
We are biased to remain strategic sellers of CAD in the new year. Tactically, we think the week of US CPI, the Fed and ECB meetings could serve as a turning point. EURCAD is one cross that we think could have some downside into the end of the year.
That leaves USDCAD likely anchored lower for now. But we iterate that the CAD is one of the currencies we are most bearish on into 2023. With the BOC signaling that the tightening cycle is nearing an end or at a minimum, not likely to be as aggressive, focus will shift to the idiosyncratic factors that we have long warned about, especially as the Fed also downshifts. The debt binge that has supported the Canadian expansions in the past thanks to an era of low interest rates is over.
We are biased to remain strategic sellers of CAD in the new year. Tactically, we think the week of US CPI, the Fed and ECB meetings could serve as a turning point. EURCAD is one cross that we think could have some downside into the end of the year.
Rates Strategy
Big picture, we face CAN-US spreads near the richest levels they have gotten over the past 30 years, but we still see room to run towards -100bps in 5s (supported by our Canadian debt sensitivity narrative and the US avoiding a hard landing for at least the first half of 2023). However, we see more edge out the curve where there is a lot more room to flatten versus the US. We see this flattening move supported by Canada's return to issuing less 10s and longs relative to shorter tenors. Additionally, we will continue to tactically trade with the strong extension months (April/June/Sept/December), especially when they map up to a month without a 30y auction as we have seen in June/Sept/December this year. We do want to emphasize these periods of higher demand and lower supply tend to be the key catalyst months for bigger picture narratives to shift into motion.
From an outright duration and outright curve point of view we sit with a neutral posture where 30y yields and the 10s30s curve sit near the middle of the range since hikes began. We prefer to use bull-flattener/bear-steepener expressions to navigate the market going forward when not pairing off duration and curve trades against the US or other markets. For now, we hold tight, and "hope" that we aren't missing the next leg of a large duration rally. Year-end volatility and stubborn inflation pressures are core reasons why we are sitting on the sidelines, but we will be aggressive in buying duration dips if we get the opportunity.
From an outright duration and outright curve point of view we sit with a neutral posture where 30y yields and the 10s30s curve sit near the middle of the range since hikes began. We prefer to use bull-flattener/bear-steepener expressions to navigate the market going forward when not pairing off duration and curve trades against the US or other markets. For now, we hold tight, and "hope" that we aren't missing the next leg of a large duration rally. Year-end volatility and stubborn inflation pressures are core reasons why we are sitting on the sidelines, but we will be aggressive in buying duration dips if we get the opportunity.
Director and Chief Canada Strategist, TD Securities
Director and Chief Canada Strategist, TD Securities
Director and Chief Canada Strategist, TD Securities
Vice President and Macro Strategist, TD Securities
Vice President and Macro Strategist, TD Securities
Vice President and Macro Strategist, TD Securities
Director and Senior Rates Strategist, TD Securities
Director and Senior Rates Strategist, TD Securities
Director and Senior Rates Strategist, TD Securities
Director and Senior FX Strategist, TD Securities
Director and Senior FX Strategist, TD Securities
Director and Senior FX Strategist, TD Securities