Risk is Just a Four Letter Word

What a start to the shortened holiday week in Canada. Data and news came out fast, furious, and decidedly negative overnight ,and into the wee hours of the morning. Lets unpackage it and see what it all means. While you were sleeping, we had: Chinese import/export numbers that fell well below consensus, Italy had a surprise announcement to tax banks on profits due to higher interest rates, and Moody’s decided to continue last weeks theme and downgrade some banks.

China, or in the words of a former President ” CCCCHHHHIIIINNNNAAAAA ” had some economic data released overnight that was well below consensus. Imports fell over 12%, and exports fell over 15%. China is considered an economic growth engine, so this does not bode well for the global economy. If the growth engine if the world slows down, it could have implications on Canada.

Not to be outdone, the Italian Government decided to announce a surprise tax on banks. The tax, which equates to 40% of profits is meant to even the score so to speak since banks are making record profits in the face of higher interest rates. Of course this plays well with voters, but starts to de stabilize the banking sector. Right now, the banking sector around the world is still recovering from this Spring’s sudden collapse of SVB and others, so trying to check the patient out of the hospital before the wounds heal is a less than optimal solution. We might remember Canada implemented a similar tax in last years budget, however it was well choreographed, and it was 1%, rather than 40% all of a sudden. Banks are very large corporations, and they cannot move on a dime. This will force banks to either increase spreads, or reduce lending. As credit around the world tightens, this could well play into credit becoming even tighter. Lets not forget that banks are globally connected, as we all saw in 2008, and a small issue across the pond can have implications in the US and Canada.

Not to be outdone by the lowering of the US Debt ratingl ast week, Moody’s kept on rolling this week with some downgrades of US banks, and negative outlooks on others. While the very large banks like JP Morgan, Bank of America, Wells Fargo and the like avoided any negativity, banks like M and T, Truist, and a lot of regional banks got hit square in the jaw. This sent the banking sector in the US ,and around the world on a downward spiral in the stock market. Again, the financial and banking sector are still trying to recover from SVB’s collapse this year, and we are not healed yet. A negative downgrade and negative watch tells us that the rating agencies perhaps see some trouble boiling below the surface. Let’s also remember that ” The Too Big To Fail Canadian Big 5 ” have SUBSTANTIAL presences in the US ,and are extremely intertwined with US finances. Few people realize it, but TD has more branches in the United States than they do in Canada. While any issues with the US banking sector would probably be a net benefit to Canadian Banks over the long term ( they would pick up assets cheap as they did coming out of 2008 ) it doesn’t mean that they won’t see the side effects. Credit liquidity can dry up quicker than a creek in a drought, and could lead to further tightening across the financial system.

Lets not beat around the facts – There is trouble brewing. My crystal ball is no better than anyone else’s, but there is a heap of trouble coming our way. No one knows what it will be that causes the ignition, but we are quickly getting to the ” straw that broke the camel’s back ” point in the economic cycle. We have been playing with gun powder far too long, and someone is about the light a cigarette. Consider some economic numbers:

Unemployment in Canada has risen for 3 straight months, housing markets are once again dropping, and have formed a beautiful head and shoulders pattern ( we will dive deeper into that in a future blog ) Central banks are running up against a wall of raising rates again, credit balances are growing, bankruptcies are growing, power of sales are increasing ( albeit from a very low base ), and the average Canadian is really starting to feel the pinch.

Today the Canadian 5 year bond was once again lower on the news overnight, and finished around 3.82, well off last Thursday intra day high of 4.08%. Once again, the Canadian 5 year bond could not hold the 4.00% mark, and has trended lower on both Friday, and Tuesday, after being closed for the holiday Monday. However, don’t expect mortgages rates to drop. With all fo the uncertainty in the system with the China news, bank taxes, and ratings and credit downgrades, banks will be building in risk premium to the rates. While the cost of funds in the market may have gone down on funding off of the bond, the cost won’t go down to the average Canadian for quite some time. Hell, it is completely possible we see mortgage and credit rates INCREASE even though the bond is dropping.

It is gonna be one hell of a week in the markets, and