Is the BoC Doing Enough?

Markets shrugged off BoC communications
Inflation language still treats 2% as a ceiling…
...which won’t help to lift expectations and get back to target...
...while the steps taken today were minor ones
BoC reduces total GoC bond purchases…
…by shifting away from short-dated bonds…
…that it seeks to control with forward guidance…
...while focusing on longer-term purchases with greater effect
BoC offers a roughly three-year rate hold pledge…
…that is weaker than curve control which was not discussed
Finance Minister says monpol is “running out of bullets”…
...and further tees up a coming fiscal response…
…that might have held the BoC back today

There was no shock and awe in the Bank of Canada’s overall set of communications this morning (here, here and here). In fact, the overall guidance appears to be well short of ‘crushing it’ in my opinion. CAD was little changed in the aftermath of the communications, but it had been depreciating ahead of time with the driver being Covid-19 effects on global risk appetite. The Canada curve was also little affected post-communications with less than a basis point rise in the two-year yield.

Here is what they did on policy measures:

Purchases of Government of Canada bonds were reduced to “at least” C$4B/week which is down by $1B from previously.
GoC bond purchases will now be skewed toward longer-term bonds in the 3, 5, 10, 15 and 30 year segments of the curve but with MPR guidance (page 25) that purchases in the 3- to 15-year maturities tend to have the greatest effect on household and business borrowing rates. Watch for the next statements of operational details ahead of the next secondary market purchases of GoC bonds for elaboration on what they are targeting in what proportions.
Guidance on how long the purchases will continue remains vague and simply states they will continue "until the recovery is well underway." Macklem has previously defined that point to be somewhere between the initial stages of recovery and closure of the output gap, though he did not repeat that today or offer anything else. For modelling their balance sheet I've tended to assume until mid-2021 as a middle ground, but it could be longer.
Forward guidance was moderately strengthened. They did so by now attaching a statement-codified timeline to the closure of the output gap and achievement of the 2% inflation target sometime in 2023 until which rates will remain on hold. Previously they had indicated they would not hike until this was achieved but did not attach a timeline in the statement. This shouldn’t really surprise many by way of new information. It’s priced, and we had already largely figured this to be roughly the case.
Table 1 summarizes key Canadian forecast revisions.

Don’t confuse old fashioned forward guidance with yield control as some commentary has done. Yield curve control was not discussed in either written form or during the press conference today. We still do not have any indication whatsoever of what the BoC thinks about the risks and merits to more formalized curve targets or control. Instead of embracing this new tool, the BoC is using the old-fashioned tool of forward guidance that former Governor Poloz loathed but his predecessor embraced. It’s important to note that this is a less rigid, more malleable and less committal form of rate commitment than a yield cap or target on, say, two-, three- or five-year Government of Canada bonds. As Macklem himself put it, “we emphasize the uncertainty around the projection and will update as things unfold.” We’ll see over time whether Macklem’s embrace of forward guidance stands up to Poloz’s prior reticence to embrace the concept because of low confidence in the ability to forecast over the longer haul and hence deliver on such guidance.

There are several reasons for skewing GoC purchases toward longer maturities. The BoC’s official line is that there are other tools like forward guidance to control shorter yields while focusing purchases on longer-term maturities can have a more beneficial impact on key household and business borrowing costs. When asked in the press conference whether they were reducing shorter-dated purchases because of concern they may be distorting markets, the question was generally ducked. The BoC also emphasizes that they already own more of the front-end in Canada than the Fed does in the US and so shifting purchases toward longer maturities could bring this more into line with the international experience (see chart 3-A in the MPR here).

Governor Macklem was asked to clarify his stance on negative rates. He answered that negative rates are in the toolkit but that in the current situation it would not be helpful. He said that “the bar would be very high” to implementing negative rates and that it was not discussed in their deliberations.

Recall the issue here is that negative rates can’t be in the toolkit if the BoC’s estimate of the effective lower bound is positive 25bps. The ELB is supposed to be the lower bound below which risks to easing outweigh benefits.

Also recall that the BoC’s definition of the ELB was -50bps from December 2015 when a research paper and speech were delivered to support this estimate. That lasted until April of this year when the ELB was redefined to be +25bps with no further explanation or supporting research. Further, the BoC has gone from saying negative rates are in the toolkit from December 2015 until March when Governor Poloz said “we don’t like the idea” and then Governor Macklem stated on May 1^st and subsequently that they are in the toolkit. They may never arrive in Canada, but the BoC would have to clarify its framework before exploring them if that point ever were to arrive.

Overall, markets may remain unconvinced that the BoC is doing enough. The language of holding until hitting 2% with a shut output gap continues to convey that it’s a ceiling which says to markets that inflation will average out below 2% over the cycle. There is no Carney-esque reference to working the range in a flexible inflation targeting approach during a crisis as was the case during the GFC. Therefore, there is no reference to tolerating an overshoot to get to 2% on average. Accordingly, market- and business-expectations for inflation remain well below target because the BoC continues to convey the notion that it will tighten around a 2% inflation rate which likely means inflation averages lower than that over a cycle. By doing so, plenty of options for further stimulus are left untapped. For more on this perspective, please see last evening’s Closing Points (here) and the prior note on inflation (here).

After the communications ended, Finance Minister Freeland took the unusual step of declaring that monetary policy was “running out of bullets” against the tendency of Finance Ministers not to directly comment on monetary policy matters. Regardless, she went on to indicate that the onus is on fiscal policy which further reinforces expectations for an aggressive package with postponed fiscal anchors.

Is that a reason behind why the Bank of Canada held back and did relatively little new today? Quite possibly in my view. Governor Macklem repeated that standard BoC practice is not to incorporate speculation toward potential fiscal policy moves in their forecasts rather than incorporating them after they’ve been announced. It’s likely practical of market observers to nevertheless note that the BoC is not operating in a policy vacuum and has tended to strongly coordinate moves with the Federal Government. As such, I believe the Governor has in the back of his mind full awareness of a potential fiscal policy overshoot forthcoming that lessens pressure upon him to offer additional stimulus. Stay tuned for the pending Canadian Federal budget.

Please see the attached statement comparison.

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