It’s been a few months since the last commentary, and I know our vast reader base has been waiting for one so I will try my best to fill you in as well as my predecessors.
The markets have been extremely volatile this week, so a little refresher on where the key interest rates are. The 5 year Government of Canada bonds closed last week yielding 3.18% and are currently around 3.31%. The 10 years GoCs ended last week at 3.01% and are currently at 3.14%.
CMBs posted mixed performance, with 10 years outperforming 5 years, resulting in a near flat CMB curve. Literally almost flat, the 10 year CMB is yielding less than a bp higher than the 5 years right now (3.63 as of open). Compared to last week, the 5 years is 14 bps higher, and the 10 years is 13 bps higher.
I know we have been seeing all sorts of slopes in the curve for some time now but let me remind you folks, this is not normal. Yield curves plotted by maturity generally slope upwards due to liquidity and term premiums, or at least did when inflation and rate hikes were a thing of the past. Comparing these to a more typical curve, at the beginning of the year the 5 years GoC’s were yielding 1.26 and the 10 year GoC’s were yielding 1.43, that’s almost 205 bps lower than now on the 5 years and 170 bps lower than now on the 10 years.
This year has been a rollercoaster ride for the most people involved in the markets and as we have seen, interest rates can move very quickly out of our favour. Luckily, at First National we have a mid-range hedge program which allows you to lock in a rate well ahead of funding and not have to worry about any volatility that comes forth.
Bank of Canada meeting next week
As you know, the next moment of truth comes on Wednesday, when our central banks will add at least 50 and possibly 75 or a 100 basis points to its benchmark. The market has currently priced in a 72 bps rate hike for the next meeting. Rate hikes are generally in 25 bps intervals which basically means people are pricing in either a 50 bps or 75 bps rate hike, more inclined towards a 75 bp for a rate hike. The market is currently pricing in a total of 125 bps by year end.
Prime rates at the major Canadian Banks are currently set at 4.7% and the overnight rate is 2.5%. Put the calculators away, a possible 125 bps hike by year end will bring the overnight rate to 3.75% and prime to just under 6%, meaning float rate based mortgage funds for bridge and construction will cost borrowers 7% to 8% by year end. (Note to clients: consider First National’s industry leading CMHC construction program that is priced over Cost of Funds at coupons at or below Prime)
In other news
In case you missed it, Fed chairman Jerome Powell channeled his inner Volcker in the talk last week at Jackson Hole or those who can’t remember what former fed chairman Paul Volcker did, a quick history lesson. In 1979, in order to control a serious stagflation issue – high inflation, low economic growth – Volcker raised the Fed rate which averaged 11% to a peak of 20% and it wasn’t until 1985 that inflation was finally brought under control and interest rates lowered to 6%.
Here’s what Powell said:
“History shows that the employment costs of bringing down inflation are likely to increase with delay, as high inflation becomes more entrenched in wage and price setting. The successful Volcker disinflation in the early 1980s followed multiple failed attempts to lower inflation over the previous 15 years. A lengthy period of very restrictive monetary policy was ultimately needed to stem the high inflation and start the process of getting inflation down to the low and stable levels that were the norm until the spring of last year. Our aim is to avoid that outcome by acting with resolve now.”
In short, rates are probably going to keep going up until the fed thinks it has inflation under control. The next fed rate decision is on September 21st and as of right now, the markets have priced in 70.5 bps. Take that for what it’s worth given this period of high volatility and uncertainty.
Going to wrap it here, have a good long weekend with the kids before they head back to school for another dreaded year. Maybe sneak in some US open matches this weekend, last US open for Serena Williams so make sure to catch her in the earlier matches, who knows how far she will make it.