Does flatter yield curve portend a Canadian slowdown?
8/18/2018 12:21:38 PM
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By Fund Library News Wire  | Monday, May 28, 2018


 



By Aubrey Basdeo, Managing Director, Head of Canadian Fixed Income, BlackRock

The April Monetary Policy Report (MPR) from the Bank of Canada is a stark reminder of just how much the environment has changed in 2018. While on the one hand the MPR presents an economy evolving pretty much as expected, it also underscores the key risks to the macro outlook and the uncertainty about their evolution.

One area of uncertainty is the Bank’s expectation of higher potential output growth based on an expectation of higher labour productivity growth, spurred by a positive trend in investment spending. Investment spending disappointed last year, but the Bank expects it to “reassert itself” in Q2, and points to strong machinery imports in the last quarter of 2017. As for labour input growth, the Bank estimates it will remain the same as in the January MPR, but sees potential for more jobs coming online. The Bank points to a youth participation rate that “has room to increase,” as well as to labour market slack in the Oil Patch, and notes that wage growth remains below the 3% pace consistent with zero labour slack.

Yet the notion of potential is a fuzzy one. After all, it cannot be observed directly from the data – it has to be inferred. And as the Bank admits, a lot of variables that are difficult to forecast have to align to get it just right. Despite these risks, the Bank is still firmly on a path to removing accommodation, and the April MPR reinforces its data dependency in getting to the terminal overnight rate estimate of 2.5% to 3.5%. Over time, it is expecting the economy’s growth profile to shift, as household spending’s contribution declines and that of business investment and exports increases.

It’s a tidy story, but the market seems to be questioning the Bank’s picture of things going along according to plan, more or less. The biggest sign of this dissonance is the yield curve bending flat, which has historically been suggestive of a slowdown in the real world. Market-watchers are largely ignoring it, however, because the perception is that the macro environment is so substantially different, where unconventional monetary policy is still in effect even as policymakers are concurrently unwinding it. That leads to dislocations in interpreting the traditional signals.

For now, we are interpreting the Q1 data as a soft patch for growth (it has happened before), and not as the beginning of an extended downturn. Our models still point to above-trend global synchronized growth. We continue to hew to the Bank’s outlook; we do not expect it will turn around and cut rates.

Nevertheless, investors should consider some response to the risks. In our active portfolios, we are maintaining an underweight stance relative to the spread, taking on some duration risk. In this new macroeconomic environment, the signs flashing slowdown in the near term might well turn out to be false alarms. But investors should think twice about ignoring them.

Aubrey Basdeo, Managing Director, Head of Canadian Fixed Income, BlackRock, is a member of the Product Strategy Team within BlackRock's Model-Based Fixed Income Portfolio Management Group. He leads the product strategy effort in Canada for both the Institutional and iShares businesses.

Notes and Disclaimer

© 2018 by Fund Library. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited. This article first appeared in the BlackRock Blog on the BlackRock Canada website.

Important information

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

© 2018 BlackRock Asset Management Canada Limited. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. Used with permission.

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