One of the hardest football passing plays to defend is the hook or curl pattern (believe me, I played, as a defensive back, so I have plenty of experience with this). We would always be on our guard for this particular play, it was potentially a pretty easy 8 to 10 yards for the opposing offence. However, knowing that our coverage was tight, the offence always had the option of the "fake" hook and subsequent fast break toward the end zone. That left us pretty vulnerable: many a defensive back has been left in a standing still situation as the intended receiver sped downfield, wide open, with little to stop him if he caught the ensuing pass. Touchdown!
So think of the Bank of Canada as the ultimate defensive back, protecting the Canadian economy from inflation's drive to the proverbial end zone (I remember inflation at 9% and my first mortgage at 13%). The Bank of Canada thinks it has the play "read", i.e. that it has inflation covered with its recent interest rate increases as the economy speeds along and then supposedly curls back to pick up the easy 10 yard pass. However, if the Bank of Canada gets a little too cute with its coverage (of preempting inflation) and oh, oh! they are left standing still as the economy gets soft and heads south, they will be left looking around, wondering what just happened.
The Canadian economy had a strong first half of the year, but two interest rate increases and a stronger $C have definitely had a negative impact on the consumer (with record amounts of debt), housing and exports.
The yield curve has continued to flatten (short-term interest rates are up and long term rates are up less):
When the above graph (the yield spread between the 2 year Government of Canada bond and the 30 year Government of Canada bond) now at 88 basis points (or 0.88%) approaches 0, a recession will follow. Bond markets lead all financial markets.
So basically the Bank of Canada is two 1/4% rate increases away from a recession.
That is why it is very unlikely (with inflation remaining well below their 2% target) that there will be any further interest rate increases. Otherwise, they will be getting "too cute" with the economy and leaving themselves very vulnerable to getting beat for long yardage.
Tomorrow morning prior to the bank of Canada's Monetary Policy Report and interest rate announcement, my business partner and the founder of High Rock, Paul Tepsich will be the guest host on Paul Bagnell's The Street on BNN from 6am to 8am EDT.
Scott Tomenson,CIM Managing Partner, Chief Investment Strategist