The Bank of Canada (BoC) has added to its already historic suite of facilities with three key actions:¹
- Cut interest rates to 0.25%, a level the central bank calls the effective lower bound
- Launched a Commercial Paper Purchase Program (CPPP)
- Announced plans to purchase CAD$5 billion worth of government securities a week, which looks like a quantitative easing (QE) program, even if the central bank chose not to label it as such. Either way, this is a first for the BoC.
These policy actions follow a long list of previously announced facilities, including expanded term repo facilities, bond buybacks, and the purchasing of mortgage bonds, banker’s acceptances, and money market instruments, among other tools.
Note that the Canadian federal government also announced two significant policies on the same day:
- Wage subsidies for small and medium-sized businesses will rise to 75% from 10%, backdated to March 15.
- Small businesses will receive a CAD$40,000 interest-free loan for a year, where the first CAD$10,000 is forgivable.
In our view, these two policies should help reduce the number of job losses and provide some cushion to the expected coming economic contraction in Q2. From a markets perspective, while we continue to see further weakness in the Canadian dollar, we believe it could remain in the 1.40 to 1.45 range against the U.S. dollar for the time being. Crucially, we expect the Canadian yield curve to steepen, with monetary policy pinning down the front end of the curve and the continued expansion of fiscal policy to help lift rates at the long end.
Five big picture key takeaways
- The BoC isn’t targeting growth, it’s trying to restore the healthy functioning of Canadian financial markets
We’ve said it before—global central bank actions at play right now aren’t intended to prevent recessions, their goal is to calm financial markets, particularly credit markets. The BoC’s statement spent a lot of time emphasizing this: “The intent of our decision today is to support the financial system in its central role of providing credit in the economy, and to lay the foundation for the economy’s return to normalcy.”¹
On this front, we think the Canadian central bank is a little behind the U.S. Federal Reserve (Fed): Several risky and nonrisky spreads have widened recently in spite of the BoC’s existing facilities. U.S. spreads, on the other hand, have calmed over the past week,² thanks to the Fed’s announcement last week to support the U.S. credit market.
We believe the BoC’s announcement will be effective at helping to thaw Canada’s rates markets, although implementation will be important. The U.S. experience also suggests that some fine-tuning will be necessary. We’ll know within a week whether these programs will be successful.
- We’re unlikely to get negative interest rates in Canada anytime soon
Interestingly, the BoC described the current interest rate (25bps) as the effective lower bound.¹ When asked if Canada could see negative rates, BoC Governor Stephen Poloz said that while these were theoretically in its toolbox, research undertaken by the BoC since 2015 has shown that negative interest rates could have “significant negative impacts” on the financial system.³ Given that the BoC’s primary focus is to restore functionality to the financial markets, negative interest rates are, in Governor Poloz’s words, “not sensible.”³ His remarks are consistent with our view that the BoC isn’t considering negative interest rates as a policy tool and will instead pursue other options to support the economy.
One caveat to this view is that we still don’t know who the next BoC governor will be (Mr. Poloz’s term ends in June this year),4 and new leadership may take the bank in a different direction.
- Whether it’s formally called QE or not-QE, we’re going to have it for a long time, which could change the shape of the yield curve in Canada
For the first time, the BoC will “begin acquiring Government of Canada securities in the secondary market. Purchases will begin with a minimum of $5 billion per week, across the yield curve.”1 However many ways we look at it, the announcement still sounds a lot like QE. His argument was that the program isn’t about nudging interest rates lower, but achieving “price clearing”³ and restoring functionality to Canada’s fixed-income market.
Interestingly, similar to the Fed’s and the European Central Bank’s QE program, the BoC’s “not-QE” has no end date. The BoC’s statement says the program “will be adjusted as conditions warrant” and will continue “until the economic recovery is well under way.”¹ This last sentence is significant because it’s essentially forward guidance, a tool that Governor Poloz has long eschewed. In our mind, this is a bigger step for the BoC than it may seem on the surface. Crucially, we believe the program will suppress the front end of the yield curve and, along with ongoing expansive fiscal policy, will be supportive of a steeper Canadian curve.
- We believe there will be more easing to come
Interest rates are at their effective lower bound, but that doesn’t mean the BoC is out of ammunition. We’re expecting the following additional forms of stimulus in the days ahead:
Yield curve control—Deputy Governor Carolyn Wilkins mentioned this during the webcast, which we believe will be introduced in both Canada and the United States. This could lower interest rates further, most likely at the front end.
The BoC is likely to expand its not-QE program—This is highlighted by the central bank’s statement, which stated that the program would be adjusted as “conditions warrant.”¹ The BoC could not only change the size of its weekly purchase but also the types of securities it buys, depending on where it sees stress in the market.
Credit easing—outright purchases of corporate bonds—is also possible—The deputy governor also made a nod to this tool in her comments.
Financing for lending programs—Funding provided to financial institutions with the condition that it’s passed on to businesses and consumers is also possible.
- The economic downturn in Canada could be harder and longer than the United States, but the country’s fiscal policy is now far more appropriately targeted
We believe the Canadian economy is entering into this downturn in a weaker state than its U.S. counterpart because of high household debt, weak business investment (lower oil prices are certainly not helping), and an overlevered housing market. In our view, the Canadian economy will take longer to recover, and the downturn may be more severe.
However, we’re confident that the federal government’s announcement of 75% wage subsidies for small and medium-sized businesses will help support the labor market; crucially, we believe the most important type of fiscal policy at this juncture is one that helps stave off job losses. In our view, these kinds of policies will allow for a less pronounced recession and, at the margin, a faster recovery.
1 “Bank of Canada lowers overnight rate target to ¼ percent,” Bank of Canada, March 27, 2020. 2 Bloomberg, March 26, 2020. 3 “COVID-19 actions: press conference (webcasts)—March 2020,” Bank of Canada, March 27, 2020. 4 “Bank of Canada Governor Stephen S. Poloz to step down in June 2020,” Bank of Canada, December 6, 2019.
A widespread health crisis such as a global pandemic could cause substantial market volatility, exchange trading suspensions and closures, and affect fund performance. For example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may arise in the future, could affect the global economy in ways that cannot necessarily be foreseen at the present time. A health crisis may exacerbate other pre-existing political, social and economic risks. Any such impact could adversely affect the fund’s performance, resulting in losses to your investment.
Investing involves risks, including the potential loss of principal. Financial markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. These risks are magnified for investments made in emerging markets. Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a portfolio’s investments.
The information provided does not take into account the suitability, investment objectives, financial situation, or particular needs of any specific person. You should consider the suitability of any type of investment for your circumstances and, if necessary, seek professional advice.
This material, intended for the exclusive use by the recipients who are allowable to receive this document under the applicable laws and regulations of the relevant jurisdictions, was produced by, and the opinions expressed are those of, Manulife Investment Management as of the date of this publication, and are subject to change based on market and other conditions. The information and/or analysis contained in this material have been compiled or arrived at from sources believed to be reliable, but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness, or completeness and does not accept liability for any loss arising from the use of the information and/or analysis contained. The information in this material may contain projections or other forward-looking statements regarding future events, targets, management discipline, or other expectations, and is only as current as of the date indicated. The information in this document, including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Manulife Investment Management disclaims any responsibility to update such information.
Neither Manulife Investment Management or its affiliates, nor any of their directors, officers or employees shall assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained herein. All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment or legal advice. Clients should seek professional advice for their particular situation. Neither Manulife, Manulife Investment Management, nor any of their affiliates or representatives is providing tax, investment or legal advice. This material was prepared solely for informational purposes, does not constitute a recommendation, professional advice, an offer or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security or adopt any investment strategy, and is no indication of trading intent in any fund or account managed by Manulife Investment Management. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Diversification or asset allocation does not guarantee a profit nor protect against loss in any market. Unless otherwise specified, all data is sourced from Manulife Investment Management. Past performance does not guarantee future results.
Manulife Investment Management
Manulife Investment Management is the global wealth and asset management segment of Manulife Financial Corporation. We draw on more than 150 years of financial stewardship to partner with clients across our institutional, retail, and retirement businesses globally. Our specialist approach to money management includes the highly differentiated strategies of our fixed-income, specialized equity, multi-asset solutions, and private markets teams—along with access to specialized, unaffiliated asset managers from around the world through our multimanager model.
These materials have not been reviewed by, are not registered with any securities or other regulatory authority, and may, where appropriate, be distributed by the following Manulife entities in their respective jurisdictions. Additional information about Manulife Investment Management may be found at www.manulifeam.com.
Australia: Hancock Natural Resource Group Australasia Pty Limited, Manulife Investment Management (Hong Kong) Limited. Brazil: Hancock Asset Management Brasil Ltda. Canada: Manulife Investment Management Limited, Manulife Investment Management Distributors Inc., Manulife Investment Management (North America) Limited, Manulife Investment Management Private Markets (Canada) Corp. China: Manulife Overseas Investment Fund Management (Shanghai) Limited Company. European Economic Area and United Kingdom: Manulife Investment Management (Europe) Ltd. which is authorised and regulated by the Financial Conduct Authority, Manulife Investment Management (Ireland) Ltd. which is authorised and regulated by the Central Bank of Ireland Hong Kong: Manulife Investment Management (Hong Kong) Limited. Indonesia: PT Manulife Aset Manajemen Indonesia. Japan: Manulife Asset Management (Japan) Limited. Malaysia: Manulife Investment Management (M) Berhad (formerly known as Manulife Asset Management Services Berhad) 200801033087 (834424-U) Philippines: Manulife Asset Management and Trust Corporation. Singapore: Manulife Investment Management (Singapore) Pte. Ltd. (Company Registration No. 200709952G) Switzerland: Manulife IM (Switzerland) LLC. Taiwan: Manulife Investment Management (Taiwan) Co. Ltd. Thailand: Manulife Asset Management (Thailand) Company Limited. United States: John Hancock Investment Management LLC, Manulife Investment Management (US) LLC, Manulife Investment Management Private Markets (US) LLC and Hancock Natural Resource Group, Inc. Vietnam: Manulife Investment Fund Management (Vietnam) Company Limited.
Manulife Investment Management, the Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.