By Michael O’Neill

Interest rates are heading higher in the United States. In Canada, it won’t just be rates getting higher.  If Statistics Canada data can be believed, so will about 16 percent of Canadians. Cannabis became legal in Canada on October 17, and 16% of Canadians reported using it in the past three months.  The quarterly National Cannabis Survey was released on August 9.

The Fed hiked rates 0.25% on September 26, 2018.  The CME FedWatch tool (as of October 18,) suggests the odds are 75% for another increase in December.  The minutes from the September Federal Open Market Committee (FOMC) warned that there could be even more increases than previously expected.

The minutes said a few participants were concerned that US interest rates would need to rise above the Fed’s assumed “longer-run level” to reduce the risk of inflation overshooting the inflation target.  That idea isn’t new, and the fact that Fed officials discussed the prospect shouldn’t have surprised anyone.  However, Bond traders seemed to be taken off guard.  US 10 and 20-year Treasury yields soared almost 2.0% after the minutes were released, before giving back half of those gains in trading the next day.  The rise in US Treasury yields undermined the Canadian dollar as Canadian bond yields didn’t keep pace, even though the Bank of Canada has a hawkish bias.

The Bank of Canada, like the Federal Reserve, believes its policy rate is below what they consider “the neutral” rate of interest.  The Bank believes the neutral rate is between 2.5% and 3.5%.  The current rate is 1.5%  which gives them plenty of room to move.  Economists, strategists, and analysts almost universally expect the BoC to hike rates on October 25 and many expect another hike on January 9, 2019.

Even if they hike twice, Canadian rate increases will just match the moves in the US while still leaving domestic rates below the neutral rate.  However, the new United States Mexico Canada Agreement (USMCA) on trade may give the BoC room to hit the rate hike accelerator.  The BoC said that trade uncertainty reduced the levels of business investments and exports.  Governor Poloz always denied that the Nafta talks impacted policy discussions.  He said the Bank was “data dependent, not headline dependent,” but admitted that the trade talks raised the level of uncertainty.  The USMCA removes the uncertainty, suggesting domestic rates could rise further and faster than previously expected.

The USMCA deal cuts a lot of the uncertainty about US/Canada trade although the US tariffs on Canadian steel and aluminum are still in place.  President Trump has an “itchy” trigger finger when it comes to imposing tariffs.  He isn’t a big fan of Prime Minister Trudeau, either, which means he could take a serious look at the complaints of Derek Peterson, CEO, and Chairman of Terra Tech Corp.

Mr Peterson’s company is an American cannabis company. He feels threatened by the new Canadian cannabis industry, so much so that he took out a paid advertisement in the Wall Street Journal on October 16.  The advertisement is in a letter format that starts with “Dear Mr President.”  He writes “Canada is threatening to deprive American farmers, workers, and businesses from the prosperity that rightly belongs within our borders.”  That line will resound with Mr Trump who campaigned on “Make America Great Again,” promising to bring manufacturing jobs back home.  Perhaps he will copy Canada’s supply management program and create a Cannabis Marketing Board.

The US/Canada trade spat may have been mostly resolved, but that isn’t the case with the US/China war.  Trump may be emboldened after Mexico and Canada bowed to his trade demands and expect the same result from China.  He hasn’t acted on his threat to add tariffs on another $267 billion of China imports, but he hasn’t taken it off the table either.  He took another shot at China on October 17 when he started the process to pull the US out of the 144-year international postal agreement.  The United Nations treaty was designed to lower costs for poor or developing nations.  Under that agreement, China is considered a developing country.  Chinese retailers get a 40%-70% discount to send small packages to the US.  American’s don’t think it is fair.  China narrowly dodged a bullet when the US Treasury found that China was not manipulating its currency which President Trump has often accused them of doing.  However, they are still on Treasury’s watch list.

President Trump took aim at Mexico again in a Twitter tirade on October 18.  He threatened to put the US Military on the Mexican border if officials there don’t do more to prevent illegal border crossing.  It may be an empty threat.  The Washington Post wrote that the Posse Comitatus Act of 1878, forbids using federal military personnel to enforce domestic policies.

Interest rates may drive market direction but Trump tweets fuel volatility.  Increasing market volatility suggests that more world leaders will conclude that Canada’s leaders had the right idea, and legalize cannabis in their countries.   “Smoke ‘em if you got ‘em.”