The Bank of Canada is dealing with a market that is probably hotter than previously believed, as well as the bond market’s sharpest indication yet that a recession and reduced inflation are on the horizon.
The central bank of Canada revealed to reduce inflation, the economy must cool off from its overheated levels. Its tightening drive could cause a bigger downturn than anticipated if it overshoots that goal.
That risk can be indicated by the bond market. The yield on the 10-year Canadian government bond has decreased by roughly 100 basis points underneath the yield on the 2-year bond. This is the largest inversion of the Canadian yield curve recorded by Refinitiv going back to 1994, and it is deeper than the inversion of the U.S. Treasury yield curve.
Curve inversions are regarded as recession indicators by select researchers. After taking up large amounts of debt to participate in a booming home market during the COVID-19 pandemic, Canadians are likely to be especially sensitive to increasing rates.
Karl Schamotta, the chief market strategist at Corpay, said markets believe that the Canadian economy is set to take a triple hit as a result of a decline in domestic demand, a weakening of U.S. demand, and a fall in global commodities prices.
The BoC has made it possible to slow rate rises to a quarter of percentage point after several erroneous increases in recent months caused the benchmark rate to rise to 3.75%, its highest level since 2008.
When the bank meets to announce policy on Wednesday, currency markets are wagering on a 25-basis-point increase, but a narrow majority of analysts in a Reuters poll anticipate a larger move.
According to Canada’s employment data for November, the labour market is still tight, and the third quarter’s GDP increased at an annualised pace of 2.9%.
Because of these plus increased revisions to past growth, analysts believe that demand has surpassed supply by a larger margin than the BoC’s forecasted 1.5% pace.
However, they also assert that the specifics of the third-quarter GDP figures, such as a decline in domestic demand, and an early report indicating no growth in October, are indications that increased borrowing costs have started to have an impact on activity.
BoC’s predictions claimed from this year’s fourth quarter to the middle of 2023, growth would stagnate.
David Rosenberg, the chief economist & analyst at Rosenberg Research, said the severity of Canada’s curve inversion indicates a “severe recession” rather than a minor one.
Due to an increasingly inflated residential property market and consumer loan bubble, Canada faces a larger danger to the outlook than the US, as per Rosenberg.
After inflation moved from the cost of products to the cost of services and labour, where higher prices may become more entrenched, it is likely to remain longer. However, the BoC’s carefully studied 3-month underlying inflation indicators, the CPI-median and CPI-trim, show that price pressures are lessening.
Stephen Brown, a senior Canada economist at the Capital Economics, estimated that they decreased to an average of 2.75% in October. That is far less than the more typical 12-month prices.
Brown stated the yield curve wouldn’t invert to this degree unless investors also thought that inflation would decrease back toward the Bank’s target.
The BoC’s inflation objective is 2%, the same as the Federal Reserve’s.
By the look of the curve, the Bank of Canada will be compelled to reverse course by the end of 2023, with rates remaining low for years to come, or so is claimed by Corpay’s Schamotta.