There has been a lot pounding of the arena glass since the Bank of Canada raised interest rates on Oct. 24.
“If there are typos in this missive, it’s because I’m still shaking my head,” David Rosenberg, a famous Bay Street analyst, wrote after policy makers announced that they had reset the Canadian benchmark rate at 1.75 per cent.
Ted Carmichael, an economist and long-time observer of the Canadian scene, tweeted
that he “couldn’t agree more” with Rosenberg, adding that “things aren’t nearly as rosy as the Bank of Canada believes.” Martin Pelletier, a portfolio manager at Calgary-based TriVest Wealth Counsel Ltd., advised investors to get “on the other side of the Bank of Canada and their rainbows-and-unicorns outlook.”
A small sample, to be sure, and the harsh assessment of the central bank’s outlook probably represents a minority. Still, the negative reaction got the attention of Stephen Poloz, the governor. The Toronto stock exchange dropped more than three per cent over the days that followed the interest-rate increase, even though Poloz and his deputies on the Governing Council had asserted that household spending was “healthy” and that income growth was “solid.”
Stocks have recovered somewhat, but trading remains volatile. Investors appear to have forced Canada’s central bank to stress test its view on where the economy is headed. “Recent action has some commentators questioning whether many economic forecasts, including ours, are too rosy,” Poloz told an audience in London on Nov. 5. “Such a divergence between the economic outlook and market action needs to be taken seriously.”
Let’s consider that outlook for a moment. The Bank of Canada, which has been nailing its forecasts of late, predicts gross domestic product will expand 2.1 per cent this year, 2.1 per cent in 2019 and 1.9 per cent in 2020. That’s a little faster than the central bank thinks the economy can grow without stoking inflation. The jobless rate has been hovering around an historic low of 5.8 per cent for nearly a year, suggesting the economy is approaching full employment. Factories and other industrial facilities are running at levels that suggest companies’ ability to keep up with orders is maxing out.
Call the outlook “rosy” if you want, but those are the conditions that typically put upward pressure on inflation, which the central bank is mandated to contain. That’s why Poloz and his lieutenants raised the benchmark rate last month. And it’s why they signaled they will continue doing so; borrowing costs still are delivering lots of stimulus to an economy that doesn’t appear to need it.
“If Poloz believes Canada is ‘at capacity,’ and it looks like the U.S. is there too, then this is the stuff of inflation scares,” Jeff Weniger, a strategist at WisdomTree Asset Management Canada, wrote in a blog post on Oct. 29. “Of the forecasting outliers (those pencilling in 2 per cent or 2.75 per cent for year-end 2019), we think the latter camp has a better chance of being proven correct.”
The Rosenberg view deserves attention for a couple of reasons. One is that he’s been right before: the former Wall Street economist who now works in Toronto for Gluskin Sheff + Associates Inc. is among the relative few who can claim they saw something bad happening ahead of the Financial Crisis.
Rosenberg also has a large audience. His writings show up in both the Financial Post and the Report on Business, and he is often quoted by Bloomberg News and others in the financial press. The man has a megaphone, and late last month he was using it to condemn the Bank of Canada as a collection of idiots.
“How can anyone in their right mind declare that the outlook is anything close to constructive when the Chinese stock market is down nearly 30 per cent from its highs, the ex-U.S. global MSCI is off nearly 20 per cent from its 2018 peak, the entire world equity index is down 11 per cent and the TSX is down seven per cent?” Rosenberg wrote in a commentary for the Post on Oct. 25.
The Bank of Canada must attempt to weigh both the upside and downside risks and take the middle, risk-balanced path
Stephen Poloz
Let’s give the allegedly deranged leader of Canada’s central bank a chance to respond. Poloz told his London audience that he takes a longer view of equities; yes, the S&P 500 Index is off its peak from earlier this year, but it still is 35 per cent higher than three years ago, he said.
The recent slump surely has something to do with a darker outlook. But repricing is natural now that deflationary fears have passed and two-way risk has returned to financial markets. And if you look close, you see that the stock-market declines are concentrated in industries that are exposed to Trump’s trade wars.
“It is evident, therefore, that rising interest rates can explain only part of what we have observed in stock markets — trade actions are playing a central role,” Poloz said.
That explanation probably won’t satisfy the Canada bears; they seem committed to the idea that the economy is on a bad path. They could be correct. But the central bank doesn’t have the luxury of taking one side of a bet: the trade wars could wreck the economy, or they could end tomorrow. That’s why policymakers have stated repeatedly they will proceed cautiously.
“The Bank of Canada must attempt to weigh both the upside and downside risks and take the middle, risk-balanced path,” Poloz said.
Email: kcarmichael@postmedia.com | Twitter: CarmichaelKevin
