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Is BoC's Carney bluffing when he warns of interest rate hikes coming?

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  • Apr 27th, 2012 3:23 pm
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Is BoC's Carney bluffing when he warns of interest rate hikes coming?

Not an economist, analyst or a trader but here are some thoughts to ponder on.

http://www.globalnews.ca/carney+warns+o ... story.html

USDCAD trading below 1.00 (CAD is a bit stronger than the USD)

Bernanke suggested interests will stay low through to 2014. Will BoC risk traders moving CAD further up with interest rate hikes?

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He also warned traders not to bet that commodity price increases will lift the loonie up:

http://www.theglobeandmail.com/report-o ... le2407318/

The loonie trades relative to many commodity price levels (definitely not to Natural Gas though whose decade low pricing is only evident in North America). The only way to tank the CAD is for another bloodbath in the financial markets, thereby inducing "flight to safety" from CAD to USD or CHF (Swiss Franc) or YEN.

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Aussie is trading above parity as of this post:

1 U.S. dollar = 0.963205548 Australian dollars

How much of Australia's export is to the US though? Majority of it go to China and other Asian "Economic Tigers", doesn't it? For Canada, aren't at least 70% of what we export go to the US?

USDAUD can go to 0.80 and it won't impact the Australia economy as much as a USDCAD exchange rate of of 0.80 would be devastating to Ontario.

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European Union slowdown means slower growth. Also, jack up the interest rates in the US, and traders will likely demand more yield out of the EU.

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Not sure if I should trust Carney's prognosis on where interest rates will be in the medium-term (which none of us can predict anyway)

Would love your thoughts?
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A few days after Carney's warning last week, inflation came in at under 2% I think?

He might not be bluffing on purpose, but the hikes could be delayed due to world events. He can only do his best based on the information in front of him.
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...history has shown that there is only "so far" the Bank of Canada can move before the Fed before risking structural damage to the economy (ie., early rate hikes drive a higher currency and that then causes distortions for manufacturing, exports/imports etc because our trade is very tight with the US). So until the Fed begins to show signs that they are ready to move (they have persistently said not until at least 2014) then the Bank of Canada is painted into a box and probably won't be able to engage in a rate hike until mid 2013 when the Fed begins to make overtures toward also hiking.

In the meantime, I think the Bank will continue to jawbone rate expectations up like they have been doing while the fed gov't will tighten rates implicitly through policy actions (ie., via CMHC). They are doing this because both groups implicitly realize that parts of Canada's economy doesn't need emergency low interest rates that we currently have - our banking sector is definitely not stuck in a liquidity trap like the US, our output gap is effectively closed and interest-rate sensitive sectors of the economy like housing are on fire and waay over valued.
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Yes, Carney is absolutely bluffing. Deflation, not inflation, is the major concern in Canada, and deflation is in the pipeline as the housing bubble pops and people stop buying junk to fill their houses with (and employing Realtors, etc.). Demand is in the toilet and there is massive amounts of unused/underutilized capacity in Canada's economy, especially in the labour market. The output gap is gaping (despite gomyone's claim) wide, and will just get even wider as the housing sector goes into decline.

I won't re-hash the arguments I've made elsewhere, but basically, Carney's actions (ie: no interest rate hikes) speak louder than words. Hitting the CMHC debt limit basically puts the brakes slamming on credit expansion. I suspect that interest rate cuts will be needed in the next few years, as well as a domestic program of quantitative easing, as the housing collapse gains steam and the insurance claims start piling up at the CMHC against all the subprime mortgages they've guaranteed.

CAD/USD will already go to $1.2-$1.3 just on a collapse in Canadian demand when the housing bubble starts into a major implosion, while Canadian exports remain relatively robust. Carney isn't going to make the same mistake as John Crow (circa 1989) in raising the rate against a rapidly weakening domestic economy.
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mc_molineux wrote: A few days after Carney's warning last week, inflation came in at under 2% I think?
I personally think he's frustrated about an unregulated rogue bank in the Canadian economy (CMHC) that is driving unsustainable credit expansion and artificially lowering interest rates for extremely risky credits, but can't publicly comment on how outrageously bad government policy is in this respect.
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Mark77 wrote: I personally think he's frustrated about an unregulated rogue bank in the Canadian economy (CMHC) that is driving unsustainable credit expansion and artificially lowering interest rates for extremely risky credits, but can't publicly comment on how outrageously bad government policy is in this respect.

+1 on that. His job would be a lot easier if he could get some co-operation from the government re: CMHC. He knows it's bad, the big 5 know it's bad in the long term (not for them... they're insured, but for the economy) hence their comments about increasing government regulation. But the government is looking the other way for fear of being blamed when homeowners lose "equity" when prices fall due to reduced availability of credit.
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mc_molineux wrote: +1 on that. His job would be a lot easier if he could get some co-operation from the government re: CMHC. He knows it's bad, the big 5 know it's bad in the long term (not for them... they're insured, but for the economy) hence their comments about increasing government regulation. But the government is looking the other way for fear of being blamed when homeowners lose "equity" when prices fall due to reduced availability of credit.

The government is kind of in a corner as well, as when the lynchpin breaks on the CMHC, the housing market probably will collapse. Basically the government wants to be able to blame BoC for the collapse. The BoC would like to blame the government. But neither want to be seen as the public trigger of that collapse.

The longer it continues, of course, the more overcapacity ends up being stimulated in the sector, which just deepens the severity of the crash. Commenters need to keep in mind that a housing price collapse/decline also tends to imply much lower construction costs, which means it can take many years to fully liquidate the excess capacity once even a glut appears.
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I don't know whether he is bluffing or not, but the Bond Market is saying that there will be at least a .25 point rise before the end of 2012. :|
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angelok wrote: I don't know whether he is bluffing or not, but the Bond Market is saying that there will be at least a .25 point rise before the end of 2012. :|

There has been a little bit of a sell-off, but an average rate of 1.42% (source: http://www.bankofcanada.ca/rates/intere ... ian-bonds/) for the 1-3 year maturities is actually less than a year ago. If forward short-term bond yields were an awesome predictive tool, certainly they were predicting even higher rates a year ago.

The >10 year debt is at 2.55%. Basically, if these are useful predictive tools, and rates were going higher in any significant way, the yields would be much greater in anticipation. 2.55% for >10 years basically shows the 'market' has extreme confidence in not only the 2% inflation targetting of the BoC, but also, that rates are not headed significantly higher for a long time.

Carney may very well be correct -- rate hikes are coming for mortgage/housing borrowers, though, as banks/lenders increase risk premia applicable to housing-backed instruments. The distinction between retail 'rates', and the BoC policy targets is an important one, especially as banks and lenders generally shift their preferences towards other forms of credit.

Many businesses in the Canadian economy are severely under-leveraged, and banks definitely have some pretty awesome opportunities to grow their businesses by providing credit such that the owners of those businesses can cash out. Some sectors in the economy are practically devoid of credit, such as gold mining, and the technology sector, amongst others.
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Mark77 wrote: I personally think he's frustrated about an unregulated rogue bank in the Canadian economy (CMHC) that is driving unsustainable credit expansion and artificially lowering interest rates for extremely risky credits, but can't publicly comment on how outrageously bad government policy is in this respect.
"Canada’s primary lender of taxpayer-backed mortgages is coming under tighter oversight, as new legislation will require Canada Mortgage and Housing Corp. to report to the national banking regulator."

No. He is not.
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manmanny wrote: "Canada’s primary lender of taxpayer-backed mortgages is coming under tighter oversight, as new legislation will require Canada Mortgage and Housing Corp. to report to the national banking regulator."

No. He is not.

That's an extremely recent development, and the damage (ie: malinvestment) induced by CMHC's activities didn't happen overnight. The legislation hasn't even been passed yet. And whether they will be properly regulated in the best interests of national economic and monetary policy remains to be seen.
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Mark77 wrote: That's an extremely recent development, and the damage of the CMHC's rogueness didn't happen overnight. The legislation hasn't even been passed yet. And whether they will be properly regulated in the best interests of national economic and monetary policy remains to be seen.
NO. He is not.

I am just posting what I am reading right now, watching the game.
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manmanny wrote: NO. He is not.

I am just posting what I am reading right now, watching the game.

What are you reading? Of course, we're all speculating (because none of us have Mark Carney's brain), but he has expressed concern that he lacks the policy tools (ie: the ability to shut down the CMHC) that would allow him to better manage monetary policy.

Central bankers, of course, generally stay out of politics, and stay out of making statements that are specific to certain institutions or sectors of the economy. Mindful of this tradition, Carney can't come out, outright, and say that CMHC is a giant problem and timebomb waiting to explode.
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+1, Carney is no fool.. he knows that CMHC has caused markets to reach their limits and going forward CMHC is basically doing irresponsible lending, policy and credit expansion. There is simply too much risk now and the housing market is out of control. Things are not making logical or fundamental sense.

The problem is they would play political career suicide by calling out the CMHC like it should be.

This recent change of CMHC no longer falling under Human Resourses Canada (wtf btw?)is not expected to really make any major changes with CMHC policy at this point.
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Jungle wrote:
This recent change of CMHC no longer falling under Human Resourses Canada (wtf btw?)is not expected to really make any major changes with CMHC policy at this point.

Yup, in the USA, Fannie Mae and Freddie Mac masqueraded as private corporations, even though, as it turned out, both firms ultimately had recourse to the full faith and credit of the United States.

In Canada, our equivalent (albeit a far more dangerous version of) seemed to have existed under the guise of a social service, "helping" Canadians own homes.
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gomyone wrote: ...history has shown that there is only "so far" the Bank of Canada can move before the Fed before risking structural damage to the economy (ie., early rate hikes drive a higher currency and that then causes distortions for manufacturing, exports/imports etc because our trade is very tight with the US). So until the Fed begins to show signs that they are ready to move (they have persistently said not until at least 2014) then the Bank of Canada is painted into a box and probably won't be able to engage in a rate hike until mid 2013 when the Fed begins to make overtures toward also hiking.

In the meantime, I think the Bank will continue to jawbone rate expectations up like they have been doing while the fed gov't will tighten rates implicitly through policy actions (ie., via CMHC). They are doing this because both groups implicitly realize that parts of Canada's economy doesn't need emergency low interest rates that we currently have - our banking sector is definitely not stuck in a liquidity trap like the US, our output gap is effectively closed and interest-rate sensitive sectors of the economy like housing are on fire and waay over valued.

you don't understand what you say
if output gap is closed there is no danger to damage the economy through rate hikes and when output gap is closed and some part of economy like housing is clearly overheated there is an emergency need to hike rates no matter what happens in US or anywhere else
CAD appreciation can be managed through other ways like capital control or even direct intervention

after bubble is popped they can lower rates again but for now law interest rates causing distortions for the economy and not exchange rate
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kashirin wrote: you don't understand what you say
if output gap is closed there is no danger to damage the economy through rate hikes and when output gap is closed and some part of economy like housing is clearly overheated there is an emergency need to hike rates no matter what happens in US or anywhere else
CAD appreciation can be managed through other ways like capital control or even direct intervention
The 'output gap' is, loosely defined as the difference between the economy's potential output, and its actual output. In other words, capacity utilization.

The problem with the view (ie: gomyone's) that the 'output gap' is closed (or near to it) is that we all know that unemployment is very high, and investment in productivity enhancement has been fairly low.

Canada suffered no bout of high inflation circa 1999-2000, when employment rates reached record highs, and unemployment rates were at record lows. Capacity actually proved to be extremely elastic in the economy, such that, when the economy was at or near the threshold of a closed output gap, capacity expanded substantially, leading to massive economic growth at that time.


after bubble is popped they can lower rates again but for now law interest rates causing distortions for the economy and not exchange rate


That may very well be what happens, but the changes happening to the CMHC are actually quite profound.
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http://www.greaterfool.ca/2012/04/26/fi ... ent-167560
Now you all know why David Dodge ‘resigned’ from the BOC.

He would have NEVER allowed this insane lending to occur on his watch.

His attempt to hold the head of CMHC accountable and question the minister ended his governship of the BOC shortly thereafter with his ‘resignation’.
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