Heating Up

Things are heating up….and I don’t mean the weather. Today was quite the day in interest rate circles. The US released their inflation numbers for March, and they were up a lot more than expected. Inflation stopped cooling down, and heated up in March, reversing a trend of easing price pressures. Instantly on the release of the report the US 10 year note yield was up over the all important 4.50%, and stock markets took a whooping.

The news didn’t get much better for Canadians once the BOC held rates, and put a bit of cold water on a potential June rate cut. Odds of a June rate cut dropped to 70% after the presser today, a significant drop from 86% heading into the meeting, and the Canadian 5 year yield headed toward the sky, up almost 15 bps on the day.

Of super concern is a gauge in the US report called the ‘supercore’ inflation reading. Now this isn’t thermal dynamics, or nuclear rocket fuel terminology, but rather an inflation gauge that a lot of economists use to really break out the parts of inflation. Supercore inflation strips out the volatile food and energy portion of inflation, but it also strips out rent and shelter payments. The theme for every mortgage broker in Canada for the last 12 months has been to blame the shelter costs for the rise of inflation. Arguments have been made to strip out the housing component to make inflation look lower than it actually is. Okay, well if we use supercore in the US as the gauge – we have one hell of a problem. Supercore inflation in March was up more than any category in the entire inflation index. In fact, supercore inflation in March was the highest it has been in almost 2 years, coming in around 5.0% year over year. Now, maybe Canada and the US are diverging enough that supercore won’t be that high in Canada, but if it is – hold on.

With today’s US inflation report, the talk of a rate cut from the US Fed went from “how many will they do” to “will they move at all in 2024”? It is now a case of If, not when for 2024 in the US.

Against this backdrop of white hot inflation, a Fed on the sidelines, the decisions for Tiff and Co become a whole lot more complex. As I have said, the BOC does not have a Canadian dollar mandate. However, as I have also discussed, if the BOC moves without the Fed with it, then look out below for the CAD. Not to say it can’t happen. Hell, I think a lot of us remember a 65 cent dollar in our lifetime, however, that was then, and the world is a lot different now. With the current climate in Canada, the economic environment, and the globalization that has occured since the last time we had a 65 cent dollar – can we make a go of it? Not sure, but I think we may be about to find out.

The decision for Tiff and Co is now down to 2 options:

1. Drop interest rates and suffer the consequences of a falling Canadian dollar, declining investment confidence from international markets and ultimately the return of inflation due to higher prices for imported goods.
2. Hold rates high to keep in line ( or at least close ) with the US Fed, and have Canadians feel the pain of higher interest costs – especially as a shit tonne of mortgages come up for renewal in the next 18 to 24 months.

Neither of these options is a good one, but it may be a case of picking the best worst option. The Canadian dollar lost almost a full cent vs USD this morning, a combination of a weakening CAD, and a strengthening USD all at the same time. We are less than 6 days until we see Budget 2024, and I am sure the money presses will be up and running to finance all of the promises from the government. Look for some movement is bond pricing, yields, and currency if the budget is a real whopper of a spending hole.

June rate cut odds are slowly slipping from view, but if we see a couple inflation reports that really show inflation dropping, we see unemployment spike, and we see restraint from the feds on their budget next week – a 25 bp rate cut in June is possible. Of course, I could also lose 25 pounds, give more to charity, stop swearing, and become a better all around person. Anything is possible, and I put the odds of both those things occuring at about the same.