Bay Streeters are a little edgy this summer.
There’s the yield curve, which shows short-term yields are about the same as longer-term ones, a relationship that tends to signal a recession. There’s Donald Trump. There’s a diplomatic spat between Canada and Saudi Arabia, which reportedly prompted the kingdom to sell off its maple-flavoured assets this week.
And there are memories of what they were doing last summer — or more accurately, not doing, as angry bosses and clients would eventually tell them.
Stephen Poloz and his lieutenants on the Bank of Canada’s policy committee raised interest rates on July 12 and then went mostly quiet for the rest of the summer. Impressive economic indicators continued to roll in, including a report by Statistics Canada that showed gross domestic product grew at an annual rate of 4.5 per cent in that second quarter.
That was much faster than anyone had predicted, including the central bank. But few adjusted their outlooks for interest rates. Yet when policymakers gathered early last September, they surprised almost everyone by raising borrowing costs at consecutive announcements.
Bay Street’s shock was best expressed by Douglas Porter, chief economist at BMO Capital Markets, who called the lack of foreshadowing by the Bank of Canada an “epic fail.”
The central bank’s spokesman, Jeremy Harrison, took the unusual step of responding to Porter directly. Harrison said in a statement that market prices had put the odds of an increase at about 50-50; in other words, Porter, don’t blame us for your mistake. “Evidently, a much higher percentage of trading desks were correctly interpreting the bank’s prior messaging that monetary policy would be forward-looking and data dependent,” Harrison said.
The episode appears to have had an impact. There’s been a noteworthy shift in the quality of research over the past year. The closest watchers of the Bank of Canada have mostly stopped waiting for policymakers to tell them what they intend to do. They are increasingly making bolder forecasts based on their own assessments of the data.
Ahead of last month’s interest-rate decision, Stéfane Marion, chief economist at National Bank Financial, broke from the pack and called on the Bank of Canada to leave borrowing costs unchanged. And last week, Jean-François Perrault, chief economist at Bank of Nova Scotia, stuck out his neck by predicting the central bank will lift interest rates next month, repeating last year’s back-to-back increases.
It was a brave call because almost everyone else thinks Poloz and his advisers will wait until at least October.
This is what Poloz hoped would happen when he stopped giving guidance early in his tenure. Divergent points of view helps the central bank because a real debate on Bay Street could flag points that authorities might have missed. It also could make the financial system safer by encouraging more hedging. Perrault is in the minority, but the former finance official is a smart guy. He might also know his way around Ottawa better than many of his peers. The September interest-rate announcement no longer is a one-way bet.
“Markets appear to be significantly underpricing the odds of additional monetary policy tightening in Canada through the middle of next year,” Perrault told his clients in an update of Scotia’s economic forecasts published Aug. 2. “We think Governor Poloz will be compelled to raise rates in September even if market pricing hasn’t adjusted by then.”
Like last summer, the data are beating expectations. GDP appears to be running ahead of forecasts, aided by record merchandise exports in June and a decent amount of business investment.
StatCan added another positive on Aug. 10 when it reported that the jobless rate dropped to 5.8 per cent in July, a level that many economists equate with full employment. Adjusted for American statistical methods, some 62 per cent of the Canada’s working-age population had a job in July, compared with 60.5 per cent in the United States.
The latest labour figures weren’t impressive enough to shift the consensus that the Bank of Canada will wait until the autumn to raise interest rates, but you can tell some are thinking about it. The Institute of Fiscal Studies and Democracy’s real-time forecast of quarterly GDP growth was predicting 3.2 per cent for the second quarter after incorporating the 54,000 jobs that StatCan said were created last month. The Bank of Canada’s current estimate: 2.8 per cent.
“A good set of numbers that will keep the market guessing between September and October,” said Avery Shenfeld, chief economist at CIBC World Markets, adding that he is sticking with his October prediction.
Almost as important as the debate over policy are the economists who are conducting it.
There always was dissent. You could count on short sellers to try to poke holes in the market consensus, or maybe an economist at a boutique investing house who had an image or an ideology to uphold.
But economists at the big banks and institutional investors tended to form packs, and there’s a reason for that. They have more at stake, as they serve more clients and they play a role in supporting their institution’s brand. Therefore it’s safer to stick with the consensus view.
So it was impressive to see Scotia break out on its own. At the other end of the spectrum, Aubrey Basdeo, head of fixed income at BlackRock Canada, who almost as boldly is ignoring recent data and sticking with his prediction that the Bank of Canada will wait until early 2019 to raise interest rates.
Basdeo said the latest export numbers are likely being affected by companies stockpiling ahead of tariffs. He doubts U.S. demand will maintain its second-quarter momentum, and he said it remains unclear how higher interest rates will affect consumption.
“We’ve got issues,” he said in an interview on Aug. 9. “Why tempt fate when time is on your side?”
Unlike last year, some of the Bank of Canada’s leaders will be speaking before their September interest-rate decision: Carolyn Wilkins, the senior deputy governor, is at an event in Frankfurt on Aug. 20 and Poloz is scheduled to speak at the annual gathering of leading central bankers and economist in Jackson Hole, Wyo., on Aug. 25. And StatCan’s report on second-quarter GDP will be released at the end of the month. Those will likely be the moments on the calendar when forecasts for September change or harden.
To be sure, the trade wars could supply other variables. Poloz has said repeatedly that he won’t be swayed by headlines, only hard evidence of economic harm. Scotia’s prediction is based partly on its assumption that trade tensions will fade as Trump and his advisers are confronted with the damage their duties are causing.
But that short-term damage could be enough to persuade the Bank of Canada to leave a cushion in place. The anecdotal evidence of harm could add up quickly. Magna International Inc. this cut its outlook for sales and profit this year, blaming steel duties and Trump’s trade war with China. Earlier, Glenn Chamandy, chief executive of Montreal-based Gildan Activewear Inc., told analysts that a plan to expand production is on hold until Canada, Mexico and the U.S. resolve their differences over the North American Free Trade Agreement.
It also is worth noting that the positive surprises this year are less impressive than in 2017. So the safe bet is that the Bank of Canada will leave the benchmark rate unchanged on Sept. 5.
Still, it’s encouraging that safe is no longer the only path that Bay Street sees fit to offer.