Good News On the Inflation Front Suggests Policy Rates Have Peaked

General Bob Rees 17 Oct

Good News On the Inflation Front Suggests Policy Rates Have Peaked
Today’s inflation report for September was considerably better than expected, ending the three-month rise in inflation. Not only did the headline inflation rate fall, but so did the core measures of inflation on a year-over-year basis and a three-month moving average basis. This, in combination with the weak Business Outlook Survey released yesterday, suggests that the overnight policy rate at 5% may be the peak in rates. While I do not expect the Bank to begin cutting rates until the middle of next year, the worst of the tightening cycle may well be over.

Offsetting the deceleration in the all-items CPI was a year-over-year increase in gasoline prices, which rose faster in September (+7.5%) compared with August (+0.8%) due to a base-year effect. Excluding gasoline, the CPI rose 3.7% in September, following a 4.1% increase in August. Looking ahead to the October inflation report, the base effect for headline CPI is favourable, as CPI surged in October 2022. Gasoline prices are down about 7% so far this month. Given the war in the Middle East, however, there is no guarantee that this will hold, but if it does, the October headline CPI could move into the low-3% range.

On a monthly basis, the CPI fell 0.1% in September after a 0.4% gain in August. The monthly slowdown was mainly driven by lower month-over-month prices for gasoline (-1.3%) in September. Goods inflation fell 0.3% from a month earlier, the first time since December 2022, and grew 3.6% from a year ago versus 3.7% in August. Services inflation was unchanged from August, the first time it hasn’t grown on a monthly basis since November 2021, while the rate slowed to 3.9% on a yearly basis, from 4.3% in August.
Yesterday’s Survey of Consumer Expectations showed that perceptions of current inflation remain well above actual inflation.  One reason is the very visible level of grocery and gasoline prices. As the chart below shows, food inflation–though still elevated–decelerated to 5.9% last month, and CPI excluding food and energy fell to a cycle-low 2.8%. Large monthly gains in September 2022, when grocery prices increased at the fastest pace in 41 years, fell out of the 12-month movements and put downward pressure on the indexes.
Prices for durable goods rose at a slower pace year over year in September (+0.4%) compared with August (+1.4%). The purchase of new passenger vehicles index contributed the most to the slowdown, rising 1.7% year over year in September, following a 3.1% gain in August. The deceleration in the price of new passenger vehicles was partly attributable to improved inventory levels compared with a year ago.

Additionally, furniture prices (-4.6%) and household appliances (-2.3%) continued to decline year-over-year in September, contributing to the slowdown in durable goods. Consumers paid less on a year-over-year basis for air transportation (-21.1 %) in September, coinciding with a gradual increase in airline flights over the previous 12 months.

Other measures of core inflation followed by the Bank of Canada also decelerated.

Bottom Line

According to Bloomberg News calculations, “A three-month moving average of underlying price pressures that Governor Tiff Macklem has flagged as key to policymakers’ thinking fell to an annualized pace of 3.67%, from 4.29% a month earlier.”  While this is still well above the Bank’s 2% target, the global economy is slowing, the Canadian and US economies are slowing, and with any luck at all, the Bank of Canada might see inflation move to within its target range next year. However, the central bank will be cautious, refraining from rate cuts until the middle of next year. The full impact of rate hikes has yet to be felt. The next move by the Bank of Canada could be a rate cut, but not until next year.
Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

Residential Mortgage Commentary – Positive housing market sentiment

General Bob Rees 3 Oct

Thank you to our partners at First National for the below stats and positive info.  Enjoy!

 

 

Residential Mortgage Commentary – Positive housing market sentiment

  • Oct 2, 2023
  • First National Financial LP

An interesting new survey suggests a growing number of Canadians may be getting ready to move back into the housing market.

The newly launched survey by Dye and Durham indicates one in ten are looking to sell their primary residence and move into a new one within the next 12 months; double the number who made the move in the past year.

The number of respondents planning to expand their holdings is also up significantly with 8.0% saying they intend to buy an investment property or vacation home in the next year.  That is nearly double the 5.0% who did so in the past year.  First-time buying decisions are also getting stronger.  Eight percent of respondents expect to jump into the market, up from 4.0% who actually made a purchase in the last 12 months.

The sidelines of the housing market will still be crowded though.  The survey suggests 23% of Canadians will bide their time until interest rates come down.  Nearly a quarter (24%) say they are waiting for prices to ease.

A separate survey of people who have bought a home in the last 4 years (by a popular real estate marketplace) shows that the buying decisions of 93% of respondents were influenced by rising interest rates and competitive markets.  At the same time 43% said they wanted to buy before prices increased further.

Nearly a third (30%) of the respondents say their finances are tight right now, with 10% saying they are unable to meet basic needs.  Still, they do not regret their purchase with 45% saying they will still be happy even if there is another interest rate increase this year.

 

Bank of Canada leaves its benchmark interest rate at 5.0%

General Bob Rees 6 Sep

Bank of Canada leaves its benchmark interest rate at 5.0%

Under the heading no news is good news, the Bank of Canada decided today to keep its benchmark (overnight) interest rate steady at 5.00%, putting at least a temporary hold on a policy that resulted in 10 increases stretching back to March 2022.

At the Bank’s last meeting in July, it raised the rate 0.25% due to what it said was evidence of more persistent excess demand and elevated core inflation.

Today’s announcement from the Bank struck a similar tone but with a different outcome. We highlight its latest observations below:

Canadian housing and economic performance

  • Canada’s economy has entered a period of weaker growth, which the Bank says “is needed to relieve price pressures”
  • Economic growth slowed sharply in the second quarter of 2023, with output contracting by 0.2% at an annualized rate, reflecting “a marked weakening” in consumption growth and a decline in housing activity, as well as the impact of wildfires in many regions of the country
  • Household credit growth slowed as the impact of higher rates restrained spending among a wider range of borrowers
  • Final domestic demand grew by 1% in the second quarter, supported by government spending and a boost to business investment
  • “Tightness” in the labour market has continued to ease gradually, but wage growth has remained around 4% to 5%

Inflation facts and outlook

  • Recent Consumer Price (CPI) data indicate that inflationary pressures remain broad based
  • After easing to 2.8% in June, CPI inflation moved up to 3.3% in July, averaging close to 3% in line with the Bank’s projection
  • With the recent increase in gasoline prices, CPI inflation is expected to be “higher in the near term” before easing again
  • Year-over-year and three-month measures of core inflation are now both running at about 3.5%, indicating there has been little recent downward momentum in underlying inflation
  • The longer high inflation persists, the greater the risk that elevated inflation becomes entrenched, making it more difficult to restore price stability

Global economic indicators

  • Global growth slowed in the second quarter of 2023, largely reflecting a significant deceleration in China
  • With ongoing weakness in the property sector undermining confidence, growth prospects in China have diminished
  • In the United States, growth was stronger than expected, led by robust consumer spending
  • In Europe, strength in the service sector supported growth, offsetting an ongoing contraction in manufacturing
  • Global bond yields have risen, reflecting higher real interest rates, and international oil prices are higher than was assumed in the Bank’s July Monetary Policy Report (MPR).

Summary and outlook

In summarizing today’s decision, the Bank said “with recent evidence that excess demand in the economy is easing,” and given the lagged effects of monetary policy, Governing Council decided to hold its policy interest rate at 5% and continue to normalize the Bank’s balance sheet.

However, the Bank also noted that it remains concerned about the “persistence of underlying inflationary pressures,” and is prepared to “increase the policy interest rate further if needed.”

Governing Council noted it will continue to assess the dynamics of core inflation and the outlook for CPI inflation. In particular, it noted it will evaluate whether the evolution of excess demand, inflation expectations, wage growth and corporate pricing behavior are consistent with achieving the Bank’s 2% inflation target.

Once again, the Bank repeated its mantra of remaining “resolute in its commitment to restoring price stability for Canadians.“

Stay tuned

The Bank’s next scheduled policy announcement – the second last of 2023 – is set for October 25th. We will follow that decision closely with an executive summary the same day.

In the meantime, First National remains ready, willing and more than able to provide financing options that meet your needs. Please contact us if we can help you in any way.

Interest Rates Will Stay Higher For Longer

General Bob Rees 13 Jul

The Bank of Canada hiked the overnight rate for the tenth time today to a 22-year high of 5%. They also postponed their forecast of when inflation will hit the 2% target by six months to mid-2025. This means interest rates will stay higher for longer.
Interest Rates Will Stay Higher For Longer
The Bank of Canada increased the overnight policy rate by 25 basis points this morning to 5.0%, its highest level since March 2001. Never before has a policy action been so widely expected. Still, the Bank’s detailed outlook in the July Monetary Policy Report (MPR) suggests stronger growth and a longer trajectory to reach the 2% inflation target. The Bank of Canada believes the economy is still in excess demand and that growth will continue stronger than expected, supported by tight labour markets, the high level of accumulated household savings, and rapid population growth. “Newcomers to Canada are entering the labour force, easing the labour shortage. But at the same time, they add to consumer spending and demand for housing.”

The Bank forecasts GDP growth to average 1.0% through the middle of next year–a soft landing in the economy. “This means the economy moves into modest excess supply in early 2024, and this should relieve price pressures. CPI inflation is forecast to remain about 3% for the next year, before declining gradually to the 2% target in the middle of 2025.” This is about six months later than the Bank expected in April. This means that high-interest rates remain higher for longer.

While Canadian inflation has fallen quickly, much of the downward momentum has come from lower energy prices and base-year effects as large price increases last year fall out of the year-over-year inflation calculation. We are still seeing large price increases in a wide range of goods and services. Our measures of core inflation—which we use to gauge underlying inflationary pressures—have come down, but not as much as we expected.
There continue to be large price increases in a wide range of goods and services. Measures of core inflation have come down, but by less than expected (see chart below). One measure of core inflation–which removes food, energy and shelter prices, remains elevated and will likely continue to be sticky.

To remove base effects, the Bank looks at three-month rates of core inflation, which have remained at 3.5% to 4.0% since September 2022, almost a percentage point above the Bank’s expectations at the beginning of this year.

In addition, labour markets remain tight. Although the jobless rate has risen to 5.4%, that is still low by historical standards. The unemployment rate was at 5.7% when the pandemic began, which was considered close to full employment at the time. Job gains have been robust, with about 290,000 net new jobs created in the first six months of 2023. Many new entrants to the labour market have been hired quickly, and wage growth has been about 4% to 5%.
The faster-than-expected pickup in housing resales, combined with a lack of supply, has pushed house prices higher than anticipated by the Bank of Canada in January (see chart below). According to the MPR, “the previously unforeseen strength in house prices is likely to persist and boost inflation by as much as 0.3 percentage points by the end of 2023, compared with the January outlook.”
Bottom Line

As always, the next steps by the Bank of Canada will be data-dependent. Interest rates will remain higher for longer if the Bank is correct that inflation will not reach its 2% target until 2025. We also cannot rule out more rate hikes in the future. This morning, the US inflation data for June were released, showing a marked decline from 4% in May to 3% in June. Markets rallied worldwide, taking Canadian bond yields down despite the BoC tightening. The hardship caused by the continued rise in mortgage rates is already evident. OSFI recently announced the possibility of higher capital requirements for federally insured financial institutions on mortgages with loan-to-value ratios above 65% that have unusually high amortizations. This proposal is now out for consultation. It seems OSFI and the federal consumer watchdog are working at cross purposes.
Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

Economic growth leads the Bank of Canada to increase its benchmark interest rate

General Bob Rees 7 Jun

*** Thank you to our partners at First National for the below analysis.  Bank of Canada increases Prime by .25% today.***

 

Economic growth leads the Bank of Canada to increase its benchmark interest rate

  • Jun 7, 2023
  • First National Financial LP

Today, the Bank of Canada increased its overnight interest rate to 4.75% (+0.25% from April) because of higher-than-expected growth in Canada’s economy in the first quarter and the view that monetary policy was not yet restrictive enough to bring inflation down to target.

Leading up to today’s announcement, many economists feared that the BoC would have no choice but to raise rates in the face of persistent inflation and recent GDP growth. Their fears were founded.

To understand the Bank’s thinking on this important topic, we highlight its latest observations below:

Inflation facts and outlook

  • In Canada, Consumer Price Index (CPI) inflation “ticked up in April” to 4.4%, the first increase in 10 months, with prices for a broad range of goods and services coming in higher than expected
  • Goods price inflation increased, despite lower energy costs
  • Services price inflation remained elevated, reflecting strong demand and a tight labour market
  • The Bank continues to expect CPI inflation to ease to around 3% in the summer, as lower energy prices “feed through” and last year’s large price gains “fall out” of the yearly data
  • However, with three-month measures of core inflation running in the 3.50%-4% range for several months and excess demand persisting, concerns have increased that CPI inflation could get stuck materially above the 2% target

Canadian housing and economic performance

  • Canada’s economy was stronger than expected, with GDP growth of 3.1% in Q1 2023
  • Consumption growth was “surprisingly strong and broad-based,” even after accounting for the boost from population gains
  • Demand for services continued to rebound
  • Spending on “interest-sensitive goods” increased and, more recently, “housing market activity has picked up”
  • The labour market remains tight: higher immigration and participation rates are expanding the supply of workers but new workers have been quickly hired, reflecting continued strong demand for labour
  • Overall, excess demand in the economy looks to be “more persistent” than anticipated

Global economic performance and outlook

  • Globally, consumer price inflation is coming down, largely reflecting lower energy prices compared to a year ago, but underlying inflation remains stubbornly high
  • While economic growth around the world is softening in the face of higher interest rates, major central banks are signalling that interest rates may have to rise further to restore price stability
  • In the United States, the economy is slowing, although consumer spending remains surprisingly resilient and the labour market is still tight
  • Economic growth has essentially stalled in Europe but upward pressure on core prices is persisting
  • Growth in China is expected to slow after surging in the first quarter
  • Financial conditions have tightened back to those seen before the bank failures in the United States and Switzerland

Summary and Outlook

The BoC said that based on the “accumulation of evidence,” its Governing Council decided to increase its policy interest rate, “reflecting our view that monetary policy was not sufficiently restrictive to bring supply and demand back into balance and return inflation sustainably to the 2% target.”

The Bank says quantitative tightening is complementing the restrictive stance of monetary policy and normalizing the Bank’s balance sheet.

Going forward, the Bank said it will continue to assess the dynamics of core inflation and the outlook for CPI inflation with particular focus on “ evaluating whether the evolution of excess demand, inflation expectations, wage growth and corporate pricing behaviour are consistent with achieving” its inflation target.

Once again, the Bank repeated its mantra that it “remains resolute in its commitment to restoring price stability for Canadians.”

Next up

With today’s announcement now behind us, a new round of speculation will begin in advance of the Bank’s next policy announcement on July 12th. We will keep a close watch on the market in the meantime and report on the Bank’s next move that day.

Residential Market Commentary – Banking regulator gauges risk

General Bob Rees 25 Apr

Thank you to our partners at First National for the below update.

 

Canada’s federal banking regulator has released its second, Annual Risk Outlook.  The Office of the Superintendent of Financial Institutions (OSFI) is looking at whether to extend its mortgage guidelines, with an eye to reducing risk.

OSFI has identified, what it considers, nine “significant risks facing Canada’s financial system.”  A potential downturn in the housing market tops that list.

“OFSI is preparing for the possibility, but not predicting, that the housing market will experience sustained weakness throughout 2023,” said superintendent Peter Routledge.

High interest rates are the key concern.  Higher borrowing costs present the increased possibility of defaults.  Credit quality, however, so far looks quite strong and residential real estate remains sound, according to Routledge.

“What’s interesting now is how benign conditions have remained. Underlying that is a very strong economy … And Canadians are servicing the higher cost of debt quite handily.”

OSFI says it is reviewing its B20 mortgage guidelines in order to be better prepared for future risks.  Its existing guidelines apply to all new mortgage originations at federally regulated lenders, including both new purchases and refinances.

OSFI is also taking a closer look at variable rate fixed-payment mortgages, which keep monthly payments the same even as rates rise by putting a bigger portion of each payment toward interest.  However, some borrowers aren’t even covering interest costs, and banks are stretching out the amortization period.

Federal Budget 2023…Press the Snooze Button

General Bob Rees 28 Mar

Thank you Dr Copper for the summary 🙂

 

 
As promised, there would be nothing much in this year’s budget for fear of stimulating inflation. The federal government faces a challenging fiscal environment and a weakening economy. Ottawa promised it would err on the side of restraint. Instead, Finance Minister Chrystia Freeland announced a $43 billion increase in net new government spending over six years. The new expenditures focus on bolstering the rickety healthcare system, keeping up with the US on new clean-technology incentives, and helping low-income Canadians to deal with rising prices and a slower economy.

Tax revenues are expected to slow with the weaker economy. The result is a much higher deficit each year through 2028 and no prospect of a balanced budget over the five-year horizon.

The budget outlines significant increases to healthcare spending, including more cash for provincial governments announced earlier this year and a $13-billion dental-care plan that Trudeau’s Liberals promised in exchange for support in parliament from the New Democratic Party.

Freeland is also announcing substantial new green incentive programs to compete with the Inflation Reduction Act signed into US law last year by President Joe Biden. The most significant new subsidy in the budget is an investment tax credit for clean electricity producers. Still, it also includes credits for carbon capture systems, hydrogen production, and clean-energy manufacturing.

The budget promises $31.3 billion in new healthcare spending and $20.9 billion in new green incentive spending by 2028. On top of that is $4.5 billion in affordability measures, half of which is for an extension of a sales tax credit for low-income Canadians.

The spending is partially offset by tax increases on financial institutions and wealthy Canadians and a pledge to reduce government spending on travel and outside consultants. Freeland is planning to raise billions of dollars from banks and insurance companies by changing the tax rules for dividends they get from Canadian firms. The new tax will apply to shares held as mark-to-market assets, not dividends paid from one subsidiary to another.

Wealthy Canadians pay the alternative minimum or regular tax, whichever is higher. The government announced in the budget that it is increasing the alternative minimum rate to 20.5 percent from 15 percent starting in 2024. Ottawa is also imposing new limits on many exemptions, deductions and credits that apply under the system beginning in 2024.

“We’re making sure the very wealthy and our biggest corporations pay their fair share of taxes, so we can afford to keep taxes low for middle-class families,” Finance Minister Chrystia Freeland said in the prepared text of her remarks.

Canada’s debt-to-GDP ratio will worsen next year, despite the government’s reliance on this measure as a fiscal anchor. Debt-to-GDP will rise from 42.4% to 43.5% next year and is projected to decline very slowly over the next five years.
Not Much for Affordable Housing

The budget included a laundry list of measures the federal government has taken to make housing more affordable for Canadians.

Budget 2023 announces the government’s intention to support the reallocation of funding from the National Housing Co-Investment Fund’s repair stream to its new construction stream, as needed, to boost the construction of new affordable homes for the Canadians who need them most.

But there was one initiative tucked away in a Backgrounder entitled “An Affordable Place to Call Home.” I am quoting this directly from the budget:

A Code of Conduct to Protect Canadians with Existing Mortgages

“Elevated interest rates have made it harder for some Canadians to make their mortgage payments, particularly for those with variable rate mortgages.

  • That is why the federal government, through the Financial Consumer Agency of Canada, is publishing a guideline to protect Canadians with mortgages who are facing exceptional circumstances. Specifically, the government is taking steps to ensure that federally regulated financial institutions provide Canadians with fair and equitable access to relief measures that are appropriate for the circumstances they are facing, including by extending amortizations, adjusting payment schedules, or authorizing lump-sum payments. Existing mortgage regulations may also allow lenders to provide a temporary mortgage amortization extension—even past 25 years.

This guideline will ensure that Canadians are treated fairly and have equitable access to relief, without facing unnecessary penalties, internal bank fees, or interest charges, which will help more Canadians afford the impact of elevated interest rates.”

We will see what OSFI has to say about this, as the details are always of paramount importance. OSFI is scheduled to announce potential changes to banking regulation to reduce bank risk. We’ve heard a lot about banking risks in recent weeks.

The budget also reduced the legal limit on interest rates.  The government intends to lower the criminal rate of interest from 47% (annual percentage rate) to 35%. According to the law firm Cassels, “’Interest’ is defined broadly under the Code and includes all charges and expenses in any form, including fees, fines, penalties, and commissions.”

Bottom Line

While this was not one of the more exciting budgets, it is important that our debt-to-GDP ratio is low in comparison to other G-7 countries. It is good news that Ottawa recognizes the financial burdens facing homeowners with VRMs. If the banks can extend remaining amortizations when borrowers renew, the pressure on their pocketbooks will be markedly lower.
Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

US Policymakers Take Emergency Action To Protect Depositors At Failed Banks

General Bob Rees 14 Mar

Thank you Dr Cooper for the breakdown 🙂

 

US Policymakers Take Emergency Action To Protect Depositors At Failed Banks
Silicon Valley Bank (SVP) had a sterling reputation among the many tech start-ups it helped to finance. What brought SVB down was an old-fashioned bank run set off in 2021 by a series of bad decisions.

That year, the stock market boomed, interest rates were near zero, and the tech sector was flush with cash. Many start-ups held their working capital and other cash at SVB. The Santa Clara, Calif.-based lender saw total deposits mushroom to nearly $200 billion by March 2022, up from more than $60 billion two years earlier.

The bank invested much of that cash in long-dated Treasury bonds–normally considered a blue-chip investment. If held to maturity, the full value of the initial investment would have been returned to the bank. However, interest rates have risen dramatically since last March, causing the price of those bonds marked-to-market to decline precipitously. SVB risked large losses if it had to liquidate its securities portfolio.

This created a massive mismatch between the value of the deposits and its bond holdings. Moreover, this was not initially transparent to the depositors thanks to a 2018 relaxation of banking regulation much-favoured by SVB’s CEO. Regional banks were no longer required to mark their assets to market, nor were they required to succumb to the regular stress testing by the federal regulator where they prove they could survive black swan events. In addition, capital requirements became easier for these institutions.

In 2018, Trump eased oversight of small and regional lenders when he signed a sweeping measure designed to lower their costs of complying with regulations. An action in May 2018 lifted the threshold for being considered systemically important — a label imposing requirements including annual stress testing — to $250 billion in assets, up from $50 billion.SVB had just crested $50 billion at the time. By early 2022, it swelled to $220 billion, ultimately ranking as the 16th-largest US bank.

In 2015, SVB Chief Executive Officer Greg Becker urged the government to increase the threshold, arguing it would otherwise lead to higher customer costs and “stifle our ability to provide credit to our clients.” He said that with a core business of traditional banking — taking deposits and lending to growing companies — SVB doesn’t pose systemic risks.

Another unique problem for SVB was the unusual concentration of deposits from certain types of clients. SVB’s depositors were heavily concentrated in the tight-knit world of start-ups and venture capitalists (VCs). In the past few weeks, VCs, founders, and other wealthy customers on social media and in private chats started discussing concerns that SVB could no longer pay its depositors. Some began to move their money out of the bank, triggering a loss of confidence and a run on the bank.

A Rapid Fall

On Friday,  Silicon Valley Bank became the biggest US bank to fail since the 2008 financial crisis.

Another beneficiary of easing regulatory oversight of small and midsize regional banks was New York-based Signature Bank, which also suffered a massive withdrawal of deposits. On Sunday, regulators shut down Signature, fearing that sudden mass withdrawals of deposits had left it on dangerous footing.

The back-to-back bank failures unnerved investors, customers and regulators, harkening back to the financial crisis in 2008, which toppled hundreds of banks, led to enormous taxpayer-financed bailouts, and sent the US and many other countries into a severe recession.

Canada, on the other hand, escaped much of the pain, experiencing a mild short recession. Although Canadian bank stocks plunged, our banking system was lauded worldwide as a regulatory example for the rest of the world.

Regulators Rush to Forestall Widespread Bank Runs

US Federal regulators scrambled to defuse the situation over the weekend, announcing on Sunday that all depositors would be paid back in full.

The Federal Reserve, Treasury and Federal Deposit Insurance Corporation announced in a joint statement that “depositors will have access to all of their money starting Monday, March 13.” To assuage concerns about who would bear the costs, the agencies said that “no losses associated with the resolution of Silicon Valley Bank will be borne by the taxpayer.”

The agencies also said they would make whole depositors at Signature Bank, which the government disclosed was shut down on Sunday by New York bank regulators. The state officials said the move came “in light of market events, monitoring market trends, and collaborating closely with other state and federal regulators” to protect consumers and the financial system.

The President said on Sunday and Monday, “I am pleased that they reached a prompt solution that protects American workers and small businesses and keeps our financial system safe. The solution also ensures that taxpayer dollars are not put at risk.”

He added: “I am firmly committed to holding those responsible for this mess fully accountable and to continuing our efforts to strengthen oversight and regulation of larger banks so that we are not in this position again.”

The collapse of Signature marks the third significant bank failure within a week. Silvergate, a California-based bank that made loans to cryptocurrency companies, announced last Wednesday that it would cease operations and liquidate its assets.

Amid the wreckage, the Fed also announced that it would set up an emergency lending program, with approval from the Treasury, to funnel funding to eligible banks and help ensure that they can “meet the needs of all their depositors.”

The additional funding will be made available through the creation of a new Bank Term Funding Program (BTFP), offering loans of up to one year in length to banks, savings associations, credit unions, and other eligible depository institutions pledging U.S. Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral. These assets will be valued at par. The BTFP will be an additional source of liquidity against high-quality securities, eliminating an institution’s need to quickly sell those securities in times of stress.

The F.D.I.C. is usually supposed to clean up a failed bank in the cheapest way possible, but regulators agreed that the situation posed a risk to the financial system, which allowed them to invoke an exception to that rule. The regulator will tap the Deposit Insurance Fund, which comes from fees paid by the banking industry, to ensure it can pay back depositors.

The agencies said that “any losses to the Deposit Insurance Fund to support uninsured depositors will be recovered by a special assessment on banks, as required by law.”
Monday’s Market Meltdown

Not surprisingly, the stock markets around the world opened sharply lower on Monday. The previous day, Goldman Sachs said that any Fed rate hikes were off the table for March 22 (I disagree). Bank stocks and energy stocks were hardest hit in virtually all markets. On the other hand, bonds surged, taking interest rates down sharply.

When banks collapse, others sometimes fear their banks and investments will follow. Even healthy banks don’t keep enough cash to pay out all depositors. So, if too many people panic at once and pull out their money — a classic bank run — it could lead to broader financial and economic calamity. And that is what the Biden administration and the Federal Reserve are trying to stop: a financial crisis prompted mainly by plunging confidence.

Canada’s Banks Are In Much Better Shape

Although most Canadian bank stocks plunged on Monday, the regulatory environment is far tighter than in the US. Moreover, Canadian banks are dominated by the Big Six rather than the thousands of banks in the US. They have nationwide branch networks with a large diversified base of clients with less exposure to technology, fewer deposit runoff issues and higher ratios of loans to deposits.

There is much less hot money coming into the Canadian banks than the small and midsize regional lenders in the US that focus on a specific niche part of the loan and deposit markets. Canadian banks are also much better capitalized.

Finance Minister Chrystia Freeland met with Canada’s superintendent of federal financial institutions, Peter Routledge, one day after his office announced it had seized control of SVB Financial Group’s branch in Canada.SVB’s Canadian arm is unusual because it has a license to lend but cannot take deposits. While some Canadian startups had deposited with the bank’s U.S. arm, the Canadian operation held no client money.

SVB is a small lender in Canada. The tech financer had US$692 million in assets and US$349 million in outstanding loans in Canada as of December, according to OSFI filings. CIBC had $2.9 billion in loans through its innovation banking arm as of October 31, 2021. A bank looking to bolster its lending to startups could scoop up SVB’s loan book at a steep discount.

Yields in Canada fell sharply, following the Treasury market’s lead. Investors reversed course and bet the Bank of Canada will start cutting rates soon.

OSFI has already taken action to monitor daily the liquidity of Canadian banks in the wake of the SVB failure.
Bottom Line

Goldman Sachs was virtually alone when it said it expects the central bank to pass up the chance to hike interest rates next week. Markets still expect the Fed to keep up its inflation-fighting efforts, despite high-profile bank failures that have rattled the financial system. Traders on Monday assigned an 85% probability of a 0.25 percentage point interest rate increase when the Federal Open Market Committee meets March 21-22.

Surging bond yields played into the demise of SVB in particular as the bank faced some $16 billion in unrealized losses from held-to-maturity Treasurys that had lost principal value due to higher rates.

Is this enough to qualify as the kind of break that would have the Fed pivot? The market overall doesn’t think so.

For a brief period last week, markets were expecting a 0.50-point move following remarks from Fed Chair Jay Powell indicating the central bank was concerned about recent hot inflation data (see chart below).

Bank of America and Citigroup said they expect the Fed to make the quarter-point move, likely followed by a few more. Moreover, even though Goldman said it figures the Fed will skip a hike in March, it still is looking for quarter-point increases in May, June and July.

Next week’s meeting is a big one in that the FOMC will not only decide on rates but also update its projections for the future, including its outlook for GDP, unemployment and inflation.

The Fed will get its final look at inflation metrics this week when the Labor Department releases its February consumer price index on Tuesday and the producer price counterpart on Wednesday. A New York Fed survey released Monday showed that one-year inflation expectations plummeted during the month.
Written by;
Dr. Sherry Cooper, Chief Economist, Dominion Lending Centres

No Surprises Here: The Bank of Canada Hiked Rates By Only 25 bps, Signalling a Pause

General Bob Rees 25 Jan

No Surprises Here: The Bank of Canada Hiked Rates By Only 25 bps, Signalling a Pause
As expected, the Bank of Canada–satisfied with the sharp decline in recent inflation pressure–raised the policy rate by only 25 bps to 4.5%. Forecasting that inflation will return to roughly 3.0% later this year and to the target of 2% in 2024 is subject to considerable uncertainty.

The Bank acknowledges that recent economic growth in Canada has been stronger than expected, and the economy remains in excess demand. Labour markets are still tight, and the unemployment rate is at historic lows. “However, there is growing evidence that restrictive monetary policy is slowing activity, especially household spending. Consumption growth has moderated from the first half of 2022 and housing market activity has declined substantially. As the effects of interest rate increases continue to work through the economy, spending on consumer services and business investment is expected to slow. Meanwhile, weaker foreign demand will likely weigh on exports. This overall slowdown in activity will allow supply to catch up with demand.”

The report says, “Canada’s economy grew by 3.6% in 2022, slightly stronger than was projected in October. Growth is expected to stall through the middle of 2023, picking up later in the year. The Bank expects GDP growth of about 1% in 2023 and about 2% in 2024, little changed from the October outlook. This is consistent with the Bank’s expectation of a soft landing in the economy. Inflation has declined from 8.1% in June to 6.3% in December, reflecting lower gasoline prices and, more recently, moderating prices for durable goods.”

Short-term inflation expectations remain elevated. Year-over-year measures of core inflation are still around 5%, but 3-month measures of core inflation have come down, suggesting that core inflation has peaked.
The BoC says, “Inflation is projected to come down significantly this year. Lower energy prices, improvements in global supply conditions, and the effects of higher interest rates on demand are expected to bring CPI inflation down to around 3% in the middle of this year and back to the 2% target in 2024.” (the emphasis is mine.)

The Bank will continue its policy of quantitative tightening, another restrictive measure. The Governing Council expects to hold the policy rate at 4.5% while it assesses the cumulative impact of the eight rate hikes in the past year. They then say, “Governing Council is prepared to increase the policy rate further if needed to return inflation to the 2% target, and remains resolute in its commitment to restoring price stability for Canadians.”

Bottom Line

The Bank of Canada was the first major central bank to tighten this cycle, and now it is the first to announce a pause and assert they expect inflation to fall to 3% by mid-year and 2% in 2024.

No rate hike is likely on March 8 or April 12. This may lead many to believe that rates have peaked so buyers might tiptoe back into the housing market. This is not what the Bank of Canada would like to see. Hence OSFI might tighten the regulatory screws a bit when the April 14 comment period is over.
 

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

Residential Mortgage Commentary – Inflation & interest rates: lead characters for 2023

General Bob Rees 9 Jan

Thank you to our preferred lender, First National, for this insight into 2023 interest rate projections

  • Jan 9, 2023
  • First National Financial LP

A lot of the recent talk in financial and real estate circles has been centering on the possibility of a pause in the Bank of Canada’s aggressive interest rate increases.  Some speculate that could happen at the next rate setting, later this month.

The Bank raised rates seven times last year in an effort to rein-in galloping inflation.  It does seem to be working, but there are some stubborn sticking points.

Headline inflation, known as the Consumer Price Index (CPI), has dropped.  It was 8.1% in July and drifted down to 6.8% in November.  However, the drop from October to November was a mere one-tenth of one percentage point and the Bank’s target rate remains significantly below that, at 2.0%.

As well, the BoC’s preferred inflation measure, Core Inflation (which strips out volatile components like food and fuel), actually increased.  A simple averaging of the three components that the Bank uses to measure Core Inflation came in at nearly 5.7% in November, up from 5.3% in October.

Other factors that figure into the Bank’s plans include Gross Domestic Product and unemployment.  Canada’s GDP continues to grow, albeit modestly, despite rising interest rates.  It increased by 0.1%, month-over-month in November.  Unemployment dipped 0.1% to 5.0% in December.  Both of these tend to fuel higher wages which are a key driver of inflation.

The Bank of Canada, itself, remains firmly dedicated to battling back inflation.  Governor Tiff Macklem has said he would rather over-tighten than under-tighten and run the risk of having high inflation linger and become entrenched.

The U.S. central bank has made it clear it plans more rate hikes.  Given the integration of the Canadian and American economies, the Bank of Canada does have to pay attention to what its American counterpart does.

The BoC will have new economic data by the time it makes its January 25th announcement.  The December numbers will provide a fresh look at how well the inflation fight is going.

Normally it takes 18 to 24 months for interest rate increases to work their way into the economy and we are only about 10 months into this tightening cycle.  It is reasonable to expect another 25 basis-point increase on the 25th.  Given the Bank’s apparent success so far it also seems reasonable to expect a pause sometime after that.

Looking ahead to a year from now some forecasters say we might start to hear talk of interest rate cuts, which would be welcome news.  Cuts would allow the BoC to move toward its, long stated, goal of normalizing rates back into the neutral range of 2.5% to 3.5%.  The Bank of Canada, and central banks around the world, have been trying to do that for more than a decade – since the ’08 – ’09 financial collapse.

 

 

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