Wrong Way Charlie

It seems these days that everything is going the wrong way. Bond yields up, currency down, and a whole host of other things that are working against us.

After last weeks bout of volatility surrounding the US election, we all hoped that things might settle down. Were we ever wrong. What started last week continues this week. It seems as though markets had a lot of re pricing to do, and they are still sifting through data, and re engineering their plans going forward.

One of the most asked questions I get is why I talk about currency so much on a mortgage blog. Apparently a lot of followers think the two items are unrelated. The reason I talk about currency so much on a mortgage blog is because the two items are more intertwined than P. Diddy and lubricant. They go hand and hand. If you want to know the future direction of interest rates, then you need to pay attention to the currency markets well in advance. Currency markets – typically called Forex, will give you insights that you only thought possible from someone who was clairvoyant.

Now, there are a few things you ought to know about the currency market before I go any further here. First and foremost, Forex markets are the largest, deepest and most liquid pool of funds in the world. Yes, the world. There are hundreds of trillions of global investments involved in forex trading. Forex trading is the market with the least amount of margin required, and the longest trading hours. Since the market is so large, so deep, and so liquid, it is the ultimate insight into how the world views a country.

A lot of stocks only trade on certain exchanges, and in certain countries. For example, if you lived in the UK and wanted to buy TD Bank stock, you would have to have a brokerage account in either the US or Canada ( which isn’t exactly easy ), convert your Pound Sterling into either CAD or USD, and then ,and only then, could you buy your stock of TD Bank. When you wanted to sell your TD stock you would have to reverse the process. But, with currencies you can always trade any currency, at any time, from anywhere in the world. It is simple, easy and attainable by everyone with an internet connection.

There is also a large consideration in currency trading that you must be aware of though, and I will sum it up to what is called a pairs trade. When you trade currencies you are not necessarily making a bet on one or the other, just that one outperforms the other. I will use CAD / USD for an easy example. If you went long the USD ( you bought USD currency ) that trade would pay well if the value of the US dollar gained against the Canadian dollar. However, it could win because the US dollar gains, or because the Canadian dollar loses – or both. When you trade currency you are betting on the outcome of the trade, regardless of the reason it gets there. So, in my CAD / USD example, I am simply betting that in my given investment horizon the value of the USD is worth more to the CAD. That could happen because the US economy catches on fire, or it could happen where the US economy treads water, but the Canadian economy gets worse. Either way, the value of the US dollar would be worth more. I am not betting on the route, only the destination.

That being said, when you make a currency trade, you have your reason for making that bet. Back in 2022 a lot of people know I moved to the US full time. When I did that a person could buy a US dollar for around $1.22 Canadian. Today of course, we know that that same US dollar is around $1.41 ish, depending on the overnight FX market. When I moved, one thing I did was I hedged about 90% of my investments to the USD. I made a bet that the USD would do a lot better than the Canadian currency. It turns out I was right, and my thesis for it worked – it could have gone the other way as well. For the last 2.5 years the US economy has outperformed the Canadian economy, and it has been reflected in the exchange rate for Canadians to buy a US dollar. It was only about 12 years ago the US dollar was at parity with the Canadian dollar. This was due in large part to the US housing collapse, and the associated mess that came afterwards.

Now, the reason I ramble on and on about all this currency mumbo jumbo in a mortgage blog is that the currency swaps markets are sending a very strong signal. Right now the amount of people that are shorting the CAD against the USD is at or near an all time high. Out of the billions of people on the planet, and the millions involved in finance, the wagers are being placed that the Canadian economy will continue to lag behind the US economy for quite some time into the future. Can millions of people all be wrong? Sure. Is it likely? Probably not. Right now people the world over are all making a wager that Canada – from an economic point is in some trouble. It wasn’t too long ago that the US economy was there as well.

Will all that being said, the reason currency trades are important is that it is basically a vote on the country. When someone buys your currency it is a vote of confidence, and when they sell your currency it is a vote of non confidence. Right now a lot of people do not have confidence the Canadian economy will perform – let alone outperform.

But why does it matter to you the mortgage agent?

The reason this matters is because most of the world now operates on a fiat currency basis ( there is nothing backing the currency like there used to be in the old days when dollars were backed by gold bullion ). Even the US Dollar bill says ” In God We Trust”. Trust is all that holds up a currency. When people sell your currency short, they don’t trust it, or the government behind it as much as they used to. The issue that creates is that if they don’t trust your currency, they also don’t trust your government bonds. A currency and the bonds they are issued in are like two peas in a pod. If people don’t trust your bonds, and don’t want to buy them, the only way you can sell them is if you make them look attractive. You do that by dropping the price of your bonds. As most of us should know by now, when bond prices drop, then the yield goes up. If Canada wants to attract bond investors, they will have to drop the price of the bonds. And let’s face it – with the deficits that the Feds are running, they need to issue bonds for the foreseeable future.

Even though Tiff and Co. put the inflation genie back in the bottle, that may not be the only reason rates were high. Sure, US news has impacted them lately, but I am not so sure that is all it is. Even though Tiff and Carolyn Rogers ( the BOC 2nd in command ) have gone out of their way, and tripped all over themselves in press conference after press conference that they are going to continue to drop the overnight rate – the 5 year government of Canada bond just logged a 3 month high. Now people will argue with me that the US bond yields are up over the same time, and I will agree with that, but the economy in the US is performing better – bond yields should be up. The Canadian dollar has continued to float lower and lower and lower – seemingly almost every trading day since Sept 24 ( ironically shortly after the US Fed did their emergency 50 bp drop, and should have caused the CAD to rally higher ). It has been a while since I have seen this unrelentless straight line from a currency trade ( outside of collapsing 3rd world currencies ) in a very long time. The last time I saw a currency fall so methodically was the lead up to the 2007 great recession in the US. And no, I am not predicting that, I just think it is funny how things work out sometimes.

Gold is also on a tear, up about 30% YTD- although it has dropped about 8% since last weeks election results. A dropping CAD and rising gold prices are 2 ingredients that tell me things are not exactly looking rosy. Canada has a big oil patch, and that can usually be counted on to help out – but our friend oil is down 21% since peaking out earlier in the year.

All of these things coming together tell me that interest rates may be bumpy, and the direction may not be the direction you think. While we typically think that the worse the economy gets – the lower rates go, it may work out in a negative feedback loop whereby the lower the overnight rates go, the less confidence investors have the in the economy, so they bid bond prices down, and yields up on fixed terms. Canada could be a Charles Dickens quote where it could be the ” best of Times ” for variable rates, and “worst of times ” for fixed rates. But of course, as soon as too many people go to the variable, the banks will reduce spreads on the variables, so instead of Prime -1.00%, they will drop it to Prime -.75%. Always have, and always will, so the variable mortgage will not be as much of a saving grace as you might think.

But, as we go into what could be a dark winter financially, it means we are that much closer to coming out the other side. In order for change to occur, you always have to have the pendulum swing too far one way. When everyone is short CAD, when rates go up, when real estate drops, and when everyone least expects it, that is when the Canadian economy will outperform. It might be a couple months, it might be a couple of years, or it might take a decade, but regardless of the time horizon, the currency markets will sniff it out first, sniff it out often, and give you a good indication when the tide is about to turn. Currency typically starts to move about 18 to 24 months before the change is noticeable, so watch the dollar closely. Watch it against the USD, watch it against the Euro – watch it against any other currency you want to. When CAD starts to strengthen it will tell you we are around 18 months or so away from things getting truly better.

Until that time, wrong way Charlie may be the only direction for yields, for prices, and for the Canadian economy.