Tiff Macklem returns to the Bank of Canada as governor, surrounded by several colleagues he has been involved with in the past. His term officially begins on Wednesday, June 3, with the 10 a.m. monetary policy decision.
The first COVID-19 wave has faded but the range of possible outcomes relative to COVID-19 and the economy remains large, as shown on chart 11, page 18 of the April Monetary Policy Report. Thus, the flexible forward-guidance sent to financial markets at the end of the mid-April statement should remain intact:
“The bank’s governing council stands ready to adjust the scale or duration of its programs if necessary.”
Missing from the mid-April statement, renewed trade tensions should be acknowledged in Wednesday’s statement.
Macklem mentioned during his nomination press event in early May that he sees the 0.25% overnight rate target as the effective lower bound, in line with outgoing governor Stephen Poloz’s view. Under the scenario of a modestly constructive economic recovery, the policy rate could stay at 0.25% until 2022. It is difficult to say more until we find out about the magnitude of the second infection wave. Deputy Governor Tim Lane also reinforced the BoC’s preference of not going into negative territory in his most recent speech:
“But zero or negative rates come at a cost—they can impair the function of key funding markets.... This is particularly true if the banks pass these negative rates on to their depositors. That is the opposite of what we want to achieve at a time when the system is already under tremendous strain.”
Since markets price in no material change to the policy rate for quite some time, the focus has shifted to the rapid balance sheet expansion. Assets on the BoC’s balance sheet soared from $120 billion (5% of NGDP) mid-March to $464 billion (20% of NGDP) in late May. Relative to the size of the Canadian economy, the pace of asset purchases from our central bank has been faster than the UK, the Euro Area and Japan so far. More importantly, this 15-ppts increase in the BoC balance sheet-to-NGDP ratio is close to the 13-ppts rise observed in the U.S. (from 20% to 33%). Matching the Fed’s expansion in terms of the balance sheet-to-NGDP ratio appears a minimum for two reasons.
First, the oil shock exacerbates the recession in Canada relative to the United States.
Second, the money supply expansion intended by QE interventions tends to have a larger effect on the currency when short-term benchmark interest rates are constrained by the lower bound according to various IMF, BIS and central banks research papers.
Granted, the BoC does not make projections or target the value of the Canadian dollar. However, it would be preferable for Canada’s economic recovery if the CAD does not appreciate versus the USD because of a gentler response by the BoC relative to the Federal Reserve’s current open-ended approach. We do not plan to target the USD/CAD in the 1.40-1.50 range unless Macklem announces at some point more this year a more aggressive asset purchases plan relative to the Federal Reserve.
Finally, in addition to how much the BoC is buying in dollar terms, the kind of securities purchased obviously matter. Adjustments to the multiple purchasing programs will continue to occur along the way due to changing markets’ needs and liquidity challenges. In respect to the composition of the BoC’s balance sheet, let us highlight:
· the outstanding of commercial paper held diminished by $1 billion in May to reach the level observed in early April;
· the pace of provincial money market securities held increased at a slower pace since the Provincial Bond Purchase Program was launched in May;
· in the Financial System Review, the BoC noted an improvement in the corporate bond market liquidity although only four securities for a total of $21.5 million were purchased during the May 26th Corporate Bond Purchase Program operation;
· the BoC bought $700 million of Real Return Bonds on the secondary market for the first time last week, as part of the Large Scale Asset Purchases (LSAP);
· Speaking of LSAP, the breakdown continues to reveal an elevated share (56%) of the total federal nominal bonds held by the BoC have a maturity date in the 2021-2024 bucket.