TORONTO: Strange things are afoot with central banks these days as many are following the U.S. Federal Reserve’s lead and looking to tighten monetary conditions by raising interest rates. While we like to think that we chart our own course, Canada is no different in playing follow-the-leader as evident by the historical correlation in interest rate movements between our two countries and the recent indications by the Bank of Canada and its governor Stephen Poloz.
In particular, Canadian bond yields are now implying a 91.4 per cent probability that the Bank of Canada will raise interest rates this week, according to recent analysis by the Financial Times. This is up from the 4.6 per cent recorded just over 30 days ago. What is interesting is that there has been no change in the Bank’s outlook since its last two meetings and the economic data — other than the recent jobs report — has either been in-line with or slightly below the Bank’s expectations. While a 25 basis points hike may not sound like much, it has certainly had a meaningful impact to the Canadian dollar and bond market over the past month. Government of Canada Marketable Bonds with terms from one to five years have seen their yields increase 75 per cent since the beginning of June.
The loonie has now delinked from its historical relationship to oil prices and has gained an impressive 7 per cent against the U.S. dollar since May and could soon surpass the US$0.80 mark. While a higher loonie is great for those of us who vacation south of the border, it will not be good for our energy producers, who sell oil in U.S. dollars, and our overall balance of trade on a national level. The debt-heavy consumers who are driving our economic growth also don’t appear ready or able to take on higher interest rates. A recent survey by MNP Ltd. indicated that 27 per cent of Canadians who have a mortgage agree that they are in over their head with their current mortgage payments. The same survey also showed that 77 per cent of Canadians would have difficulty absorbing an additional $130 per month in interest payments on debt. That’s the cost of a Starbucks Caramel Frappuccino per day.
