By Michael O’Neill
Three thousand three hundred years ago, Greek philosopher Aristotle said, “Those that know, do. Those that understand teach.” Today, he would say, “bond traders that know, do. Those that don’t work at the Fed.”
Bond traders are worried about rising inflation. They believe that massive US fiscal stimulus plans announced in December and March will ignite an inflation wildfire. The rapid pace of COVID-19 vaccinations and the easing (or scrapping) of coronavirus restrictions combined with stimulus cheques is expected to unleash a tsunami of pent-up buying demand. That demand will run face-first into supply constraints due to supply chain disruptions, which is an economics 101 event. Bond traders acted and drove 10-year US Treasury yields from a low of 0.996% on January 28 to 1.651% on April 7.
The Fed doesn’t see it that way. They noted that survey measures of inflation were little changed “on balance.” The Fed dismissed the jump in Treasury yields, saying the increase reflected “the improved economic outlook, some firming in inflation expectations, and expectations for increased Treasury debt issuance.”
The FOMC minutes suggest that even though the Fed has no plans to raise interest rates until they have achieved their inflation and employment goals, the Committee had a fairly upbeat economic outlook.
The minutes said that, “Participants observed that the pace of the economic recovery had picked up recently and that the economy continued to show resilience in the face of the pandemic. They noted encouraging developments regarding the pandemic, including significant declines in the number of new cases, hospitalizations, and deaths over the intermeeting period, as well as a pickup in the pace of vaccinations. In light of these developments as well as the extent of the recent fiscal policy support, participants significantly revised up their projections for real GDP growth this year compared with the projections they submitted last December.”
Neither the Bond traders nor the Fed’s view on inflation is wrong. Both groups expect it to rise. It’s a trading thing. Very few traders make money being the last in on a move. Even birds know to get up early.
The International Monetary Fund (IMF) upgraded their global growth forecast in their April World Economic Outlook, citing most of the same reasons as the bond traders. They expect global growth of 6.0% in 2021. US growth is forecast at 6.4%, while Canadian growth is at 5.0%.
Source: IMF Apr. 2021
In a nutshell, central bankers, economists, analysts, and traders expect robust growth, higher inflation, and higher rates at some point.
Let’s assume their views are correct. So, what does it mean for Canada and the Canadian dollar?
The domestic job market has transferred from the intensive care unit to a standard room (a hallway in Ontario).
In February 2020, Canada employed 19,189,000 people. By April, only 16,185,000 people were working. That’s three million jobs that evaporated in just sixty days. It has been a long, painful ordeal, but if the March 9 Labour Force Survey meets the forecasts, Canada will have recovered 80% of those losses.
Those jobs gains fueled ten straight months of economic growth, which means the economy has almost fully recovered from COVID-19. The Bank of Canada is likely to upgrade its growth forecast at its April 21 monetary policy meeting.
The economic growth is getting a boost from both fiscal and monetary stimulus. Bank of Canada Governor Tiff Macklem is adamant that domestic interest rates will not rise “until economic slack is absorbed so that the 2 percent inflation target is sustainably achieved,” which he says won’t be until into 2023.
The Federal government is doing their part. They have spent money like sailors on shore leave after six months at sea. The Fraser Institute estimates the Federal debt will blow past $1.0 trillion. Economists expect more clarity when the first federal budget in two years is tabled, April 19.
The consumer is turbo-charging economic growth. COVID-19 fatigue, and travel restrictions, have sent housing prices soaring in many areas.
The average house price in Toronto is $1.1 million after rising 16.2% in the past year. Do-it-yourselfers and back yard improvement projects have lifted lumber prices so high; they add $30,000 to the price of a new 2500 square foot home.
The Canadian economy is expected to benefit from President Biden’s $1.9 trillion infrastructure plan due to Canada/US trade’s size and importance. The White House also sent 1.5 million Astra Zeneca vaccines to Canada, greatly improving the pace of COVID-19 vaccinations.
Canada is benefitting from the 77% jump in crude oil prices since November 2, as oil is Canada’s largest export. Opec price supports combined with an expected increase in demand from a global economic recovery and forecast for even higher prices are underpinning prices.
The domestic fundamentals combined with bearish long term USDCAD technicals suggest the currency is heading towards the 85 cent level, which is a soothing massage for Canadian dollar bulls.