2020 has been an interesting year for Thomas Kim. As Vice President and Managing Director, Capital Markets, Thomas and his treasury group at First National have had front row seats to the Bank of Canada’s monetary policy fight against the ravages of COVID-19. Now that the year is coming to an end, we ask Thomas to look back at – and make sense of – key market and economic developments and what they may mean for the future. This interview was recorded in late November.
Thomas, looking back, what were the defining events of 2020?
On the economic front, I would say the sharp decline in employment resulting from the lockdown in March followed by the sharp increase in employment that followed, at least in sectors that were less affected by physical distancing requirements. And on the market side, I would suggest that the Bank of Canada’s actions in March and the federal government’s fiscal policy actions that followed were defining moments. It’s not often that we see three unscheduled reductions in the BoC’s key rate totalling 150 basis points in one month, but that’s what happens when the BoC is determined to avoid a liquidity crisis. It backed those rate decisions up with an enhanced repo program and large-scale asset purchases.
Quantitative Easing measures like you describe were first used in the 2008-09 financial crisis. Other than QE, are there any other similarities between today and the financial crisis?
This isn’t a recession that started in the real economy and it isn’t a recession triggered by the financial sector. It’s a health crisis and immediately that makes it unusual. This time around, there is no sign of any sort of market disruption because the Bank of Canada moved so decisively and quickly to avoid it. Some people would argue that the Bank punched way above its weight. That’s because on a relative basis, it did what the U.S. Federal Reserve took years to do after the financial crisis by growing its balance sheet in just a matter of weeks. It’s hard to argue with the results. The approach worked.
How did the market react to these developments?
I’m surprised at how sanguine the markets have been for the most part, despite the uncertainty caused by the virus and the political situation in the United States. Equity markets have been rising, credit spreads have been tightening, Canadian housing markets have been on a tear and all of this suggests market participants have been shrugging off these issues.
Normally, unemployment has a negative effect on the housing market. Why not this time?
Because COVID has had an uneven impact on employment. The statistics show that many people who lost their jobs in March were back at work by sometime in the summer, except those who work in sectors that are sensitive to social distancing measures and border restrictions like hospitality, air travel and food service. Some of those Canadians were in low-wage jobs and not purchasing homes in any event.
In October, the Bank of Canada said it would recalibrate QE activity to have a “more direct influence on the borrowing rates that are most important for households and businesses.” What does this mean?
The Bank stated that it would buy fewer bonds but move into longer-term maturities. The net result could be that the Bank takes more risk out of the market not less. The underlying message is they are trying to get more bang for their buck in what they are buying but it remains to be seen how much of an impact this will have because there are so many influences on rates and markets: the central bank is just one, a big one, but just one.
The BoC is on the record saying that it will not move its overnight rate until inflation sustainably hits 2% and that this may not happen until 2022. Should this be reassuring to borrowers?
I think the Bank’s message is pretty strong: we are going to have lower rates for longer. That said, I think every borrower needs to think about their own situation and their own risk tolerance when deciding on how much to borrow and over what term.
Is there a risk that with lower rates the government might increase the qualifying rate to borrow for a house?
Government policy actions are always a risk but it’s not something I’ve heard. All we hope for is that the government is thoughtful in any policy changes it makes and doesn’t favour one group over another.
Central banks generally are taking a closer look at their mandates. Is this likely to have an influence on policy decisions in future?
That’s correct, they are considering what targets make sense whether that’s an absolute inflation target, an average inflation target, an employment target, GDP target, or something else entirely. There are lots of ideas on the table now including the thought that maybe we can have sustainability lower rates – for a while anyway – without causing outsized inflation.
We occasionally hear experts talking about how low rates create asset bubbles in real estate. Do you have a view on that?
It is really hard to second guess the market as to whether prices are too high or too low. The market is the market.
In November, Canada experienced a second wave of COVID-19. Is this likely to negatively affect markets?
It’s interesting how sanguine the market is while lots of things are happening. I think people are just searching for reasons to be optimistic; we saw a big show of that on the Pfizer announcement in November when equity markets took off.
All things considered, how has First National fared this year?
Despite all of the turmoil in the world, it’s business as usual. We successfully transitioned to working from home and we continue to service our customers and investors.
This must have been an exciting year for your Capital Markets team.
We’ve tried to respond to all of the excitement, if that’s the right word, by being calm and rational. We haven’t made sudden moves or over-reacted to certain events. I think that this approach is a bit different than some lenders who have run hot and cold by being in and out of the market. We strive to be a consistent partner to all of our borrowers; a lender in all seasons if you will. This is an approach we took back in 2008 and coming out of the financial crisis, First National had a huge growth spurt and this year we’ve experienced it again. Being present in the market when other people are not works well for us.
How is it possible for First National to lend in all environments?
We have more than one dimension to our business. Our funding platform is very diverse, and with securitization and whole loan trading, we have a high degree of flexibility. Our size also allows us to weather volatility.
Looking forward, are there reasons for optimism?
I think one reason for optimism is that immigration is likely to bounce back once border restrictions end. That will be a very substantial positive for the housing sector…apartments and single-family. And most fundamentally, there appears to be reasons for optimism because of vaccine development. These factors are well outside our control so as we think about 2021, we will do what we did in 2020, which is continue to do our best to serve customers and investors as a consistent, committed lender.
To hear more from Thomas, please watch for his periodic Market Commentaries at www.firstnational.ca/commercial/resources-insights.