Bank of Canada breaks ranks

Bank of Canada breaks ranks

Bond markets generally don’t like surprises, especially when they come from Central Banks. The “pact” between investors and Central banks is that they will maintain stimulus packages and bond markets will behave themselves. One wrong word from a central banker and its 2013 all over again; “Taper tantrum” time! At some point, though, a brave central banker was always going to have to blink, go first and test the water…. step forward Tiff Macklem, Governor of the Bank of Canada. At their April meeting, Macklem announced that they would be reducing the size of their QE program by 25%, believing that the reduced level of stimulus was justified by the economic outlook. This was a more upbeat outcome than the market expected. The result: another leg higher in the Canadian dollar and Canadian bond spreads versus US Treasuries at the top end of longer-term ranges.

 

The trillion dollar question is: what read-across might there be to other countries? The obvious places to look at are Australia and the US – where both countries have reasons to be optimistic, given the current low levels of the virus, alongside meaningful central bank buying programs. But this may be too simplistic. For the Bank of Canada, they are choosing to look through the current data set and focusing instead on the expected post-lockdown bounce-back in activity. With upgraded forecasts that include an inflation overshoot in 2023, the Bank of Canada felt they had to act. 

 

This is not the stance taken elsewhere – so far. In the US, where economic recovery is most developed, the Federal Reserve are waiting “to see the data first” before acting and not looking to act on expected data. This is a subtle shift, that we have also seen from the Reserve Bank of Australia (RBA) too. The RBA are targeting actual rather than expected inflation before considering any change in policy. This “safety first” approach is aimed at ensuring the RBA don’t tighten too soon, worrying that it might stop the recovery in its tracks.  But with growth and inflationary pressure continuing to build in these economies it could be a risky strategy. As markets start to feel central banks are out of step with potentially higher than expected actual data, Central bankers may struggle to maintain their dovish stance.

 

So, whilst the Bank of Canada are the first of the major central banks to reduce their asset purchases, they will be the first of many. Markets will be sure to examine which central bank might be the next to blink.

Colin Finlayson

Investment Manager, Fixed Income

Colin Finlayson is an investment manager in the Fixed Income team and specialises in global government bonds and relative-value analysis. 

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