Chop Chop

If you listen very closely, you can actually hear all the Tik Tok relators limbering up and getting ready to dance the day away tomorrow after the BOC cut. Money markets are widely pricing in a 50 bp cut tomorrow, with 76% odds of 50 bp reduction. That is good enough to say the majority of respondents expect Uncle Tiff to chop, chop, chop away at the overnight rate.

But, before we all stretch to join in the dancing, lets take a very brief trip down memory lane. It was only 4 ish weeks ago that we saw this ‘ jumbo sized ‘ cut of 50 bps from Jerome and Co. to the South. And what has happened since? Well, not exactly anything good. In fact, Canada 5 year bond yields ( and by default 5 year mortgage rates ) are actually higher than before Jerome and the Fed decided an emergency 50 bp fire sale cut was needed in the economy. Central banks are loosing some control over the long end of the yield curve right now, and actions that central bankers take are having a reduced impact on the long end of the yield curve. Sure, the 1 and 2 year rates are coming down as expected, but the longer end of the curve remains stubbornly high. This is a problem as a lot of capital investment in a country is based around longer term yields – not the 1 and 2 year bond.

When businesses look to invest in a country, an economy, an area, etc. they generally need to borrow a lot of money to do so, and they certainly don’t want their prospects resting on the whim of a 1 year or 2 year bond. Generally businesses look at 10 years plus. So if bond yields and rates are staying higher on the long end of the curve, this makes it more expensive, and a lot more troublesome for companies to invest. That is just one of the ‘ real world ‘ implications of longer dated bonds yielding more. But lets bring it back to mortgages for a minute.

When short rates are low, and long bonds are high this will give lenders of money a very nice profit margin. Banks and lending institutions generally make their money on the ‘ borrow short – lend long ‘ premise. They borrow their funds from things like savings accounts bank account, short terms government bonds and the like, and then lend those same funds out to things like mortgages, car loans, etc. The lender keeps the difference, or the ‘ spread ‘ between the two. So, lower short term rates will make a boon for lenders. However, this will also lead to a lot of uncertainty in the mortgage market. If borrowers are borrowing on the 1 and 2 year terms due to lower rates, then they are a lot more vulnerable to potential future rate increases sooner. If for some reason the bond market vigilantes come out in full force and drive yields on Canadian bonds up, then the borrower could be faced with a much higher renewal rate in only 12 months time. Not exactly ideal for a market that is already bouncing from problem to problem. These shorter renewal terms could also become a problem if the government keeps meddling and changing the rules on a monthly basis. Someone that qualifies now may not qualify in a year if the rules change. If that borrower was on a 5 year term, they have time to pay down the mortgage, potentially increase their income with a side hustle or second job, or maybe a couple years for the home to appreciate in value and lower the LTV. But there isn’t much a person can do in 10 months to change things.

While tomorrow will likely see a 50 bp rate cut, we must also keep in mind that every time rates have been cut by 50 bps at once, the economy absolutely shits the bed within a few months. Things only ever get worse after a 50 bp rate cut. Never in the history of central banking have things improved right after a 50 bp rate cut. Now, some may argue the Canadian economy has already shit the bed, and is currently in the process of rolling over in it, but that is a moot point. No matter if Uncle Tiff cuts 25, 50, or even 75 bps things will get worse from here before they get better.

On the topic of a 75 bp cut, let’s please also remember that the 2 economists calling for the 75 bps of rate cut on Wednesday happen to be employed by the 2 big banks that seem to have the worst mortgage arrears!!! Gee fucking whiz, how about that? The people that would be saved by lower rates, just happen to be the ones calling for the larger rate cut. Well, colour me surprised. I won’t mention them by name here, but we all know who they are. In finance it is always a rule to believe half of what you see and none of what you hear. Finance, banks in particular have a magical gift for talking their own book. Banks do not give a rats ass about their customer, they only care about saving their own ass, and by default their own bonus.

While GDP keeps missing even the low bar, and unemployment remains high, we also must keep an eye to the inflation numbers. Yes, yes I know, inflation was ONLY 1.6% last month, but 1.6% added on to all the previous years of inflation is really starting to weigh on consumers. The reason inflation is low is that people don’t have any money left to buy anything!!! But, I see a larger problem with inflation going on. I know everyone looks at the headline number, but if you look at the various components in the inflation reading, it gets downright scary. Yes, overall inflation was 1.6%, but I always look at things people HAVE to buy, and things people WANT to buy. If you strip out all of the WANT to buy items, inflation is running one hell of a lot hotter than 1.6%. If your rent or mortgage payment is going up 6% a year, and your food continues to increase 2.5% a year, it doesn’t really matter that the cost of a mediterranean cruise dropped by 9% in the month. The inflation numbers are being used as a massive distraction right now to paper over or cover up that Canadians cannot afford things anymore. Sure, lowering interest rates will help, but lowering interest rates doesn’t really bring down the cost of potatoes and kiwi fruit at the Loblaws. Lowering interest rates doesn’t make the gas in the car cheaper. Now, if we get sustained reductions like we are seeing we may start to get some relief on the mortgage payments and rent prices, but, just like everyone who locked in to a 5 year in 2021 for 1.69% has enjoyed years of low payments, the flip side is that everyone who locked in last year at 5.75% will take 4 more years before lower rates help them. Remember, it takes time to heal things. Without the mortgage servicing costs and rent inflation being as high as they are, Canada is basically on the cusp of deflation. Deflation is not a path you want to cross. Time will tell if we actually tip into a deflationary environment or not, but we certainly have all the right ingredients right now.

Tomorrow will be an interesting day to say the least. I think the reaction to the rate announcement will look a lot like the upcoming US election : Half the population will be happy, and the other 50% of the population will focus on the reason for the larger rate cut. No matter what happens, about half the population won’t agree with the outcome. No matter the outcome though, Uncle Tiff has some fancy footwork to perform over the coming months as he tried to reduce rates, reduce borrowing costs, keep inflation down, keep deflation at bay, keep employment strong, and make sure the housing market doesn’t get overheated with all the rate cuts. I wish him the best of luck, and if can pull it off, it will be some David Copperfield magic level work. In the mean time, Canadians’ finances are left in the balance, and we all wonder what we have to chop, chop, chop from our budgets to be able to afford life.