Bank of Canada says goodbye to 'gradual' pace of rate hikes
Recent developments in global financial markets -- particularly rising long-term bond yields and volatile stock markets -- are a reflection of strong global economic fundamentals, not weak ones, according to Bank of Canada Governor Stephen Poloz.
In a speech on how to read recent “signals” from financial markets, Poloz played down interpretations that see recent movements -- such as flattening yield curve -- as evidence investors see the outlook as deteriorating.
Poloz instead said he believes a “more important signal” is the increase in higher long-term bond yields -- a reversal of a long-term downward trend -- which is consistent with the view the risk of deflation has been taken “off the table” and monetary policy is beginning to normalize in response to a world economy running close to capacity. Falling stock prices meanwhile are simply a reaction to that.
“These characteristics do not point to a gloomy economic outlook by any means -- rather, they are welcome symptoms of normalization,” Poloz said in a prepared text of a speech he’s giving to the Canada-U.K. Chamber of Commerce in London. “Investors can no longer expect yields to be suppressed by extraordinary monetary policies.”
The speech is consistent with an overall optimistic view of the global and Canadian economies from a central banker who has raised policy rates five times since mid-2017, making the Bank of Canada one of the most aggressive in normalizing among advanced economies.
Poloz reiterated in his speech the Bank of Canada will need to rise to “a neutral stance.”
Normalization isn’t the only factor impacting financial markets. Escalating trade tensions between the United States and China is also having a major impact in most markets -- from commodities to debt and stocks.
For example, debt and equities of trade-exposed companies have under-performed other businesses less exposed to this risk. The relative under-performance of Canada’s stock market is due to the fact it is so heavily weighted with such companies, he said.
Nor should recent weakness in commodity prices be interpreted as a signal of weakness in demand. There are nuanced factors such as slowing in Chinese growth amid trade disputes that are having an impact.
Poloz Speech Highights
- It’s important to look at signals provided by financial markets
- On equities, Poloz said low borrowing costs helped suppress volatility, something that is beginning to change.
- It’s also “logical” to expect a decline in stock prices from elevated levels if investors see the downward trend in long-term yields as over.
- “If investors are coming around to the view that expected earnings, as good as they are, need to be discounted by higher interest rates, it naturally lowers the price they are willing to pay for a given stock.
- On foreign-exchange markets, Poloz said: “it’s not a surprise that the U.S. dollar has outperformed virtually every major currency since the start of the year. This reflects the prospects for continued U.S. growth and policy-rate increases by the Federal Reserve.”
- The Bank of Canada looks at overnight index swap mark for “cross-validation”. Poloz doesn’t provide any interpretation of current OIS pricing