Blocked system? Call Poloz the plumber
Governor Poloz made it clear very quickly that today’s rate cut to the effective lower bound of 0.25%, along with the announcement of its first QE program, was to address dysfunctionality in markets in order for monetary policy to effectively provide support to the macroeconomy. This theme was reiterated a countless amount of times throughout the press conference, especially when the Governor was asked about the new QE program.
Poloz didn’t argue that the bank’s new buying scheme of C$5bn a month of sovereign debt along the curve was QE, but was intended to tighten bid/ask spreads in Canada’s sovereign bond market and return functionality as opposed to providing economic stimulus directly. Deputy Governor Wilkins highlighted the dysfunctioning markets was in part due to people moving to cash in order to deleverage while liquidity may have also dried up due to market participants working from home.
Many, including ourselves, had expected the QE announcement on the April 15th meeting given the increasing credit strains in Canada’s credit market. However, in the current market climate, it is likely that such monetary actions are announced outside of meetings should conditions warrant.
On the topic of negative rates, Governor Poloz said they remain on the table. Previous comments by the BoC Governor that date back to 2015 suggests the BoC still has another 75bps of conventional easing space until investors turn to cash assets, with a speech dating back to 2015 highlighting that the “theoretical lower bound” is around -0.5%. Lessons drawn from other developed economies suggests that the pace of rate cuts will substantially decrease on the way to negative territory and unconventional tools will become more favourable than cuts to the overnight rate. Today’s cut now sees the BoC join the Bank of England and the Fed at their respective effective lower bounds. The BoC is now truly the Fed’s laggard as the commercial paper scheme and open-ended QE program is also reminiscent of earlier announcements by the US central bank. The BoC will likely follow the path trailblazed by the Fed and BoE in this vein, with more unconventional monetary tweaks such as commercial mortgage bond purchases, increased monetary financing operations for municipalities or increase the purchase of corporate securities.
With respect to currency markets, the BoC fielded no discussion on why the Fed’s swap line hadn’t been extended via repo operations to the primary market.
While this could be attributed to the fact that cross-currency basis swaps no longer exhibit a large premium for USD access, it also suggests that the BoC are content with the level of loonie weakness. We argued earlier in the week when USDCAD was trading back up at 1.45 that this would provide a ceiling for the pair, while a bottom to USDCAD may be formed by verbal intervention from Governing Council members like that seen in H2 2019.
To summarise, today’s BoC announcement was merely to address a plumbing issue via the means of flushing out the blockage and to quote the Governor himself a more “coherent story” will be available at the Bank’s next policy meeting.
Graph: loonie set to break 3-day winning streak after BoC announces surprise rate cut and open-ended QE program
Graph: the overnight lending rate returns to the ’09 floor, also known as the effective lower bound
Author: Simon Harvey, FX Market Analyst