A review of bonds and the Federal budget

  • Andrew Masliwec, Analyst, Capital Markets


If you read my last commentary, you’ll know that yes, spring has finally arrived. You know what spring also brings? Tax season.  I am the furthest thing from a tax savant, but I am pretty good with present value calculations. So just know this for tax season 2019: a dollar today is worth more than a dollar tomorrow. Unless your dollars tomorrow are allocated to go see Shen Yun 2019. I’ve been told by the flyers, subway ads and no one I’ve ever met, “it’s an unforgettable experience”.

Keeping in tow with the tax-talk, Justin Trudeau released the last budget of his first or last term as Prime Minister, because if you didn’t know, there is an election this October.  Overall, many observers more in-tune than myself saw this budget as keeping close with the political headwinds faced by the government. There was no head line measure that you could run with, but there were a few initiatives that focused on workforce engagement, student indebtedness and would-be home buyers. Suffice to say most of these measures were focused around a certain avocado-eating, voting demographic. Notably absent from the budget was any notable near-term relief for businesses and the budget ignored any review of in depth changes to the tax system.  The major question would be is how this affects rates through increased future growth. Well, most things I’ve read are seeing this as a minor growth-positive budget. Which in my eyes, sounds very status quo.  Fiscally, the deficit is projected to remain unchanged relative to the Fall Economic Statement, benchmarked between $15-$20 Billion.

It’s probably worth focusing a bit overall on the new housing affordability measures enacted by this budget. The government announced that CMHC will offer a First-Time Home Buyer Incentive.  The program provides a shared equity mortgage for 5% of a resale and 10% of a new build. The program is limited to people with household incomes under $120,000 and a mortgage can only be 4x your household income. Real estate pundits and mortgage people have taken away a few negatives from this plan, the major being this generates more demand for a lack of supply. An interesting take away is that this new plan, affordability may actually be hindered since you would qualify for a smaller mortgage under the new plan versus getting a mortgage without. However, of course, under the new plan your mortgage payments would be lower, which is nice.

Moving towards the other news of the week, we had some market moving economic news and a Fed rate decision. Starting things off this morning, Canada had Month over Month retail sales for January. Retail sales came in drastically lower than expected, with the sales shrinking -0.3% vs the 0.4% expected. Interestingly enough, the ex-auto retail sales number came in bang-on with consensus growing at +0.1%. So clearly, a lot of the weakness has come from the auto sales. Regardless, the market viewed this downward revision more important than CPI numbers, and bond yields have dropped all morning.  Speaking of CPI, month-over-month, February CPI numbers came in at 0.7% vs the 0.6% expected. This brings the year-over-year number to slightly higher than expected at 1.5% vs the 1.4%. Much of this increase can be attributed to seasonality, with clothing/footwear prices up 2.8% MoM. Winter suits are now probably on sale at the Bay.  Overall, retails sales carried the headline and CPI isn’t changing much at the moment for the Bank of Canada. Looking forward to next week, there’s only one major release in Canada with GDP numbers coming out on Friday, as is tradition.

South of the 49th parallel, we had major news on Wednesday with the Federal Reserve removing the prospect of any further interest rate hikes in 2019. The Fed decided not to raise rates on Wednesday with 11 median zero dot plots showing zero chance of a rate hike this year. Obviously, the market viewed the announcement as dovish and bond yields have fallen on the back of the announcement. The Bank of Canada is now much more likely to cut rates than hike rates this year.

That all brings us to where rates are this morning.  Currently, the 5 year GOC is yielding 1.49% and the 10 year is yielding 1.59%. That’s about 10bps lower than a week ago for both. You will notice, that our current overnight target rate is set at 1.75%. Both 5 year money and 10 year money is yielding less than lending funds overnight. In fact, in a sign that investors are seeing the next BOC move as down, not up, investors have to be willing to lend at around 14 years to see a yield that matches the target rate of 1.75%.  The Government of Canada bonds due in 2033 are currently yielding 1.73%. To get a perspective of our current yield curve, there are only 6 bonds outstanding by the Bank of Canada currently yielding higher than the overnight rate. On the credit curve, CMB’s have also traded similarly with the 5 year currently yielding 1.86% and the 10 year yielding 2.05%.  That’s also 10 bps tighter than last Friday.

Finally, in the first time since 2007, the U.S. 3-month Treasury bill was yielding higher than the 10 year Treasury note this morning. What does it all mean? Well, you’ll have to keep reading these commentaries to find out.

Have a good weekend,