Jumbo The Elephant

The elephant in the room over the last couple of months has been the US Federal Reserve. Will they or won’t they? Big or small? 25 or 50? Wednesday gave us the answer, and it did cause a little bit of whiplash across stocks, bonds, and currencies.

After cutting the Fed Funds rate ( overnight rate for Canucks ) by 50 bps the markets decided to coin it a ‘ Jumbo ‘ cut. I am not sure if 50 bps qualifies as jumbo, but my wife will tell you I have always been bad with what is deemed jumbo. 50 bps is certainly more than 25 bps, but I don’t think qualifying 50 bps as jumbo is really appropriate. However, at least the elephant in the room has been acknowledged and we can all go on about our lives, right? I can already sense that the realtors of Tik Tok ( that should be a reality TV show, shouldn’t it ) are already limbering up so they don’t strain their typing hand for some more videos on why NOW is the best time to buy.

I hate to be that guy and be a buzz kill, but the fact we got 50 bps from Jerome and Co. yesterday doesn’t really translate over to Canada like some of the dancing tik tokkers and realtors may think. In previous blogs I have discussed the US Federal Reserve dual mandate. The dual mandate means the Fed keeps an eye on both inflation, AND unemployment, whereas Uncle Tiff can only use inflation as his yard stick for changing the overnight rate. This is a distinction with a difference. I won’t bore everyone with the Fed statement from yesterday, but in it they talked about inflation slowly coming down, but they spent a lot of time talking about unemployment creeping up, which gave them the comfort to cut the 50 bps. Is the Federal Reserve ahead of the curve for once in their life? This would truly be astonishing if they were.

But for Canadians, Tiff can only look across the vast openness of the border with envy. He cannot use climbing unemployment as a reason to supersize his rate cuts. Yes, unemployment will help move inflation, but with a very large, some may say jumbo, lag in the data. Unemployment has always been a lagging indicator, and can delay the actual ‘ feel ‘ of the economy by 60 to 120 days. 60 to 120 days is an eternity in bond markets. Should Canada look at adding employment to the BOC mandate? There are far smarter people than I that can weigh in on that one.

Now for a bit of the rub. Yesterday when Jerome cut the Fed funds rate by 50 bps the 10 year bond yield went UP!!!! Yes, it went up. You may also have noticed the Canada 5 year yield was basically flat on the day. So why did a JUMBO rate cut increase fixed rates? What magic witch power is that? We all knew, or should have known that the Fed rate cut was a sell the news event. However, traders are now going with the basis that since Jerome cut by 50 bps, it will avoid a US recession, and allow people to borrow more money, and actually propel the economy. So, based on this future growth the US 10 year went up yesterday by 8 or so bps, and is looking to start todays race with a bang, already up another 6 bps as of 8:30 AM EST. Remember when everyone was begging for a big rate cut? Remember how that would fix all that ails us?

Now we will start to see the difference between the 2 economies. In Canada the rates are getting cut because the economy is circling the drain. Rates are getting the Canadian chop chop because Canadians are over levered and need as much help as they can get – and that can only come from lower rates. Canadian rates need to go down to keep housing afloat. US rates are going down to help create employment, help lower borrowing costs, and help spur the largest economy in the world. Canada is doing it as a defensive move, and the US is playing offense. We all know you never win a game playing only defense.

So, as we trend into the fall, the leaves start to change colour, and the typically volatile trading season starts, we will see what Tiff can do to try and keep the wheels from falling off the apple cart. If he can balance things correctly, he may get the apples to the bakery to get some nice apple pie. If he fails, we will have a path full of apple sauce. Remember that sometimes finance works in mysterious ways, and you have to be super careful what you wish for. The dancing superstars of real estate asked for a 50 bps cut from Jerome, and they got it, but the end result was exactly the opposite of what they wanted. Remember the best laid plans of mice and men don’t always work out. Stay agile, stay flexible, remain vigilant, and help your clients navigate the potentially saucy path ahead.