A game of Twister

Remember the old classic game of twister? Red hand blue, left foot red? A game that a lot of kids spent their childhood playing seems to have faded away. Even though a lot of things come back – like baseball cards, and pogs, the game of Twister has faded off. Sure, you can still find a game of it in that old cottage you rented one summer as an Airbnb, or buried in the clearance bin at the thrift store, but people just don’t seem to be playing it anymore.

Well, Central bankers may just make Twister make a comeback. As I have blogged about before the bond market seems to be getting the best of the central bankers these days. On the Northern side of the 49th parallel in the month of October we saw 5 year government yields climb almost 35 bps in a month!!!! The same frigging month that Tiff and Co. delivered their emergency 50 basis point cut. Overnight rate down 50 bps, medium term rate up 34 bps. Even the Canada 30 year bond got in on the action and went up 25 basis points for October. Some may simply say this is the yield curve getting back to normal after a long inversion, but I am not so sure. In fact, the Canada 5 year yield is almost where it started 2024. While uncle Tiff is trying as hard as he can to chop the overnight rate without scaring the financial markets, the bond market is doing exactly the opposite to anything above a 2 year rate. This is quickly becoming Canada’s most important game of who blinks first.

Now, as we all know, people who take a variable rate mortgage should already be seeing some relief. But, there are a lot of people who just aren’t comfortable on the variable, or who don’t qualify for the variable ( remember that the variable is harder to qualify for now than a lower fixed rate thanks to a stress test ) or just can’t commit for a 5 year term ( like most variables are ). But, fixed rate shoppers are really left wondering what the fuck happened. Weren’t rates going down in 2024? According to Tik Tok relators rates were going down and it was the best time to buy. According to my local bank mortgage rep, it was better to lock in to a 1 or 2 year term because they ” knew ” rates would be lower a year from now. And yet, here we are. Rates for the most popular 5 year terms are down, but not by a lot. Certainly not near what we were promised by the social media real estate gurus.

The reasons rates are elevated are many: Canada’s fiscal policy has some market participants worried, and as such they are assigning a bit of a risk premium to Canadian Bonds. Inflation may not be slayed like the Bank of Canada ( or the general population ) thinks, and could rear its ugly head in the new year ( this is already starting to happen in some European countries where inflation is headed in the wrong direction for central bankers ) And of course, the main event – the US election. As noted earlier in the week it appears markets are pricing in a Republican win, and that is generally viewed as good for the economy. With the US economy presumed to be heating up, it means rates are going to go up a bit. A better economy leads to rate increases – contrary to what the Canadian Finance Minister says. And there could also be a glimmer of bond market vigilantes out there who think that both Canada and the US just have too much debt, and are going to make them pay up. But, no matter the reason, we do have to start considering that rates may not be going as low as we previously thought.

All of that being said, we must also keep our head open to other possibilities. Just because we may think something, or data indicates one thing – reality can quickly change. The issue that the Canadian housing market has is that the government is just so intertwined with it. A politician can make an announcement that could literally make or break a certain segment of the housing market – for better or for worse. But, even removing the government from the equation, we still must consider the immense sway that the BOC can have. The Canadian bond market is not really playing nice with the BOC and Uncle Tiff right now. Tiff is trying to bring rates down to help a struggling economy – and rightfully so. But Mr. Market is at odds with Tiff, and starting to run up yields on anything over the 2 year term. Obviously for a highly indebted nation like Canada, higher rates make it harder to dig out of the rut. This is where policy can be something that can change things overnight.

While Mr. Market is not playing nice in the sandbox with Uncle Tiff right now, there are a lot of things that the BOC can do to turn the tables on Mr. Market. Much like that one relative that flips the Monopoly board over when they are losing and stomps off, the BOC has a lot of monetary levers it can pull to ‘ flip’ the board over on Mr. Market. This is where we get back to twister.

Back in 2013 the US Federal Reserve Chairman Ben Bernanke suddenly announced one day that it would start a program that affectionately became know as Operation Twist. In 2013 the US yield curve faced the same issues that Canada is seeing now whereby the US Fed had kept short term rates low ( and most bonds from 1 year to 5 years as well ), but rates at the medium to long term of the spectrum kept going up – mainly due to the US fiscal cliff, and a general concern that the US was borrowing too much money. For the record, that was about 15 Trillion dollars ago, but it was a big concern at the time. So, Mr. Bernanke started to buy longer dated bonds (30 years ), and sell shorter term bonds ( 1-5 years ). By buying longer dated bonds, he drove the price up, and the yield down ( remember that price and yield works inversely to each other ) and by selling shorter term bonds it got the shorter term bonds up in yield. Since most financing in the US is based on the 10 year, and the 30 year, he was able to zone in and target the exact point in the curve he wanted, and manipulate yields to get longer term rates down. Sure, some shorter term yields went up, but since almost no finance for consumers is based on the 2 to 5 year rate, that didn’t really affect too many citizens. It is also important to remember that at the time, the Fed funds rate ( Canada’s overnight rate ) was already at 0.00%, so while short term yields went up, they went up very little. Short term rates are generally based on rate expectations from the Fed, and since the Fed was nowhere near raising rates in 2013, yields reflected that already. But, the 30 year mortgage rate falling had a big impact. The 10 year yield coming down ( that most car loans, bank loans, and small business loans are based on ) was huge for consumers.

Operation Twist allowed the Federal Reserve to re invigorate the US economy without really costing money to the Federal Government. It allowed them to target and move yields where it was most beneficial to the economy. Now, there were some small losses sustained in the differential of interest earned, capital losses on some of the bond portfolio, but it was nothing in comparison to juicing the US economy.

The reason I tell you this story is that I think it is very important right now to make sure that we keep our eyes open, and our minds open to things that can happen to change a situation. Could Uncle Tiff and the BOC start implement a ‘ Made in Canada Operation Twist Eh ‘? Absolutely. We can give it an acronym of MICOTE. I am not saying they do this, but, it is certainly within the realm of possibilities. Central bankers have a magical checking account at their disposal whereby they can create and destroy as much or as little money as they need at any given time. If private enterprise went in and manipulated a market for gain it would be put on trial, but the BOC has the ability to do so – legally. While the BOC claims to be independent from the government, evidence over the last 3 to 4 years shows otherwise, so if they were ever going to do something radical, I feel that going into an election would be when they would do it.

One of the most successful attempts to thwart off a depression was made after 2009 by the US Federal Reserve. The program was called Quantitative Easing, or QE for short. QE works by the central bank – in this case the US Federal Reserve buying assets and bonds from financial institutions. When the Federal Reserve bought a government bond from a bank, it would give the bank cash for the bond. Now the bank has cash, it has to loan it out. This loaned out money is used to buy houses, cars, boats, etc. etc. QE was a blue print that allowed the US economy to avoid a 1930’s style depression. For all of it’s faults, QE worked well. What many people don’t know is that the concept of QE was actually designed by the Bank of Canada. The BOC has, for years, been on the cutting edge of different monetary program research. Deep in the basement of the BOC sit a lot of people who do nothing other than come up with programs like QE to roll out in case of emergency.

While the bond market is not playing nice with central bankers right now, central bankers may have a Trump card up their sleeve ( no pun intended ). Like an Uno reverse card, Uncle Tiff could put Mr. Market down for the count. While it is certainly not my base case, central bankers are a fickle bunch, and can change their minds in a heartbeat.

Maybe it is Operation Twist, maybe it is QE, or maybe it is some other monetary program we have never heard of, but if the bond market doesn’t start co operating with Uncle Tiff, we may see some policy changes. Make sure you are well read, and keep your eyes and ears open. A policy could be announced at any moment that could completely change your career. No pundit will mention it, no bank economist will give it any air time in an interview, and no one will ‘ expect ‘ an unorthodox policy move from the BOC, but that doesn’t mean it can’t or won’t happen. A lot of financial predictions are simply parroted. One economist says something, so the rest say it. One big bank thinks one way, and so do the others. No one is ever off the beaten path with their financial predictions. But, just because no one is expecting it, doesn’t mean it can’t or won’t happen.

While we wait to see where rates go from here, let’s get the popcorn out and watch on Tuesday night to see how results start to come in. The outcome of this election will have a profound impact on the US, on Canada, and on the rest of the world. A lot of the driver of rates north of the border will be based on what comes out of the US in the coming weeks.