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5i Research Blog

Jul 13, 2017 Interest Rate Takeaways from Central Banks

By 5i

Interest Rate Takeaways from Central Banks

There has been a lot of focus on the Bank of Canada and the FED recently with talk of where interest rates are going. Here are a few things we think are worth noting.

Janet Yellen released her prepared testimony on Wednesday morning and the general theme of it was that rates can keep rising and the balance sheet can be unwound.

A recent Reuters article notes that Yellen believes the economy is on solid footing and at or beyond full employment. The FED also expects hiring and spending should lead to higher wages.  Finally, Yellen notes that the neutral rate for interest rates, or the rate at which the economy is at equilibrium, is approaching fast. This means only a few more rate hikes may be required to get the FED to a level they are happy with.

So a takeaway here is that it remains tough to be bearish on the US economy. There is no guarantee that the FED is ‘right’ on their expectations but the general outlook sounds positive and only supports the idea that the US economy is strengthening with more upside available.

The other takeaway we think that is noteworthy is that rates may not have to rise all that much. This is important for Bond bears thinking rates will skyrocket and fixed income will plummet as rates may not have all that far to go after all.

Meanwhile in Canada, the interest rate was officially raised by 25 basis points (quarter of a percent) to 0.75%. So while the Bank delivered on what markets expected, it was hesitant to provide guidance on future increases and deferred to responding to the data as it comes.

This is interesting. If we look past the rate hike that was largely expected at this point, we are actually left a little confused. With the Bank taking such a quick turn just a month ago regarding a rate hike, we would expect at least one more to be lined up given the strength in the economy that the Bank is trying to match. Tis is still a likely occurence given comments but looks more like a situation where further improvement will warrant an increase opposed to the economy already being at a place where a second, gradual increase is warranted.

But the Bank of Canada actually does not sound all that confident at this stage and already looks to be tempering the idea of future hikes. So on one hand, the Bank needed to shift policy and signal a quick change in a matter of a month or two, to adjust for the economic strength it is seeing while on the other they are citing uncertainty and financial system vulnerabilities. We think the message here is a bit confusing.

The Bank is likely worried about the impact of rising rates on the consumer and housing markets and is opting for a wait-and-see approach, which is probably not a bad thing.

The other point worth considering, is that the big move in the Canadian dollar may have been a larger and faster adjustment than the Bank expected, and they do not want to risk an overreaction to rising rates so have decided that their work is done for the time being and to cool off on the rate discussion.

Interestingly, the Canadian dollar continues to strengthen in the face of an economy that could be sensitive to increases (borrowers and real estate) and while a big driver of the economy remains lsuggish (energy). It will be interesting to watch how these rate changes work their way through the system.

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