Lisa Raitt joins Royce to give a former-insider’s view on what turned out to be a heftier-than-expected Fall Economic Statement from the Federal government. Ian and Royce then discuss the debt management strategy included in the document and its interplay with the Bank of Canada’s quantitative easing program. Ian sneaks in some questions at the end of the show about how worrisome the current strength in the Canadian dollar will be for the eventual economic recovery.
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Royce Mendez: Welcome, everyone, to another episode of Curve Your Enthusiasm. I'm your host, Royce Mendez, executive director and senior economist at CIBC Capital Markets.
Lisa Raitt: From a political point of view, a very smart move. I give a lot of credit to the minister in doing what she did, ripping off the Band-Aid, as it were.
Royce Mendez: With us this week is one of our favourite guests, the honourable Lisa Ray, who is now a vice chair at CIBC. Welcome back to the show, Lisa.
Lisa Raitt: Thank you very much. Royce, I'm delighted to be here.
Royce Mendez: We're here today to discuss the recently unveiled fall economic statement from the federal government. In these unprecedented times, I would say we saw something that was pretty unprecedented in the fall update, which was that the government released a document that looked a whole lot closer to a full blown budget, given the level of detail contained in the document, the government provided a six year outlook with a baseline deficit projection of three hundred and eighty one billion dollars for this fiscal year and one hundred and twenty one billion dollars for fiscal year twenty twenty one. After that, they see the effect on pandemic spending largely in the rear-view mirror and the effects on tax revenues fading away as the years progress, with the expectation that mass vaccination provides a significant shot in the arm for the economy. As a result, we see the all important debt to GDP ratio beginning to fall again in 2022 / 2023. The government also outlined what other scenarios might look like in which restrictions are needed for longer or needed to be tightened even further. I will say I was surprised at how hefty the document was, given that leaks to the press had us believing we weren't going to see more than a snapshot of the deficit for this year and next. Lisa, first question to you, what do you think led the government to fill in all these blanks that they could have left empty and seemingly signaled they were going to? Do you think it was just a case of under promise and over deliver?
Lisa Raitt: I think what ended up happening is that the minister, Minister Freeland, her first time out tabling something as is important as she was tabling yesterday, made the decision herself, the executive decision, that they were just going to disclose everything that they knew, that whatever information they had within Finance Canada with respect to where we were in spending and what it would look like in the future, even giving those alternative realities of what could happen. It was her decision to make sure that we were levelling or they were levelling with Canadians or we were levelled with in terms of what the fiscal situation was. And that's I think that was the leadership moment. And I think that was good for her to do that, because you can't pick around as to whether or not they're fully disclosing, they are fully disclosing what's going on. The second part of yesterday's deposit of the document is about whether or not they have a plan going forward. And that's where you're going to see the politics, I think, unroll in terms of what is really going to happen and how are we going to make sure that we pay this three hundred and eighty billion dollars back this year and what's going to happen going forward? So I think from a political point of view, a very smart move. I give a lot of credit to the minister in doing what she did, ripping off the Band-Aid, as it were. And it also shows one other interesting thing. And you point out to it, which is very important, right. Which is there is zero leaks coming out of this process of this budgeting process, which means to me that the minister has a trusted group around her, that she is in control of the file and she got to have the big surprise at the end of the day. I think it bodes well for her in the coming months.
Royce Mendez: We love having you on the show to get that insider's perspective. And I want to pick on one of the things you said, which was that there's going to be politics being played with regard to the path forward. I found it really interesting yesterday to hear from one side of the aisle that there was maybe not enough spending and from the other side to hear that maybe there was too much spending. The fact that the Liberal government has sort of everyone somewhat dissatisfied, does that mean that they're doing something right and what's their path forward? They're obviously running with a minority government. Who are they going to try to placate with finances moving forward?
Lisa Raitt: Excellent questions. I don't know how the motion of confidence comes out as a result of this document. There is going to be one because there are some significant changes. There's some tax changes that are being made and there's a change being made to something called the borrowing authority for parliament. And it's a significant change. And that may be where you see a lot of heat and light around in terms of opposition not wanting to give to the government as much leeway. It's basically an open line of credit to a ceiling of one point eight trillion dollars, I believe, when we're not even close to that amount of ability to borrow at this current time without having to go back to parliament for it normally have to go back annually. So that will be a key, I think, point of contention for the Conservatives. And maybe for the Bloc Quebecois as well, I'm going to go on the record here and say that from what I saw in this document yesterday, I don't see this government clamouring for an election in the spring. So they may want to try to make a deal. They certainly know that they have some gaps in delivering on things like child care or things like sustainable finance, things that are important in our world for sure. Instead, they didn't have an answer, so they set up a committee and action committee or an advisory committee. And that is always shorthand in Ottawa to point out the fact, look, we don't have a plan now, but we're going to come up with a plan and that's all going to be part of this one hundred billion dollar stimulus pot that we're showing you. We're going to do without telling you what we're going to do with it, but know that we're going to spend a hundred billion dollars. I don't see an election in the spring. Should they get past this hurdle of a non-confidence motion here in December. I think that they are planning on governing for a couple of years on the basis of what they put out yesterday. If they make it through the first hurdle.
Royce Mendez: Part of the reason for the wider deficits this year and next are new measures which include loans to hard hit businesses in the airline and hospitality sectors. I'm really curious to find out from you what some of the considerations that governments take into account when they need to make the decision between giving loans versus grants to highly affected sectors. Maybe you have some experie nce from the financial crisis of two thousand eight two thousand nine that you could draw on here.
Royce Mendez: Yeah, I do. And it's always the biggest question of how do you approach this from a public policy point of view. And clearly, in some cases, they've made the decision that these are going to be loans. In one case, it's going to be at one hundred percent guarantee back loan, which is really helpful, I think, for some companies out there. But the reality is the question comes down to in the case of airports, for example, at the end of the day, a lot of these airports are already owned either directly or indirectly through the land ownership by the federal government as it is. So they know that just handing them over taxpayer dollars in the form of grants isn't necessarily the best way to deal with it, because they expect and anticipate they're going to get their money back at the end of the day. And they try to set it up in the way that they want to ensure that that happens as a government. But it's not really that big a difference in terms of how you get the money to them. Clearly, with a loan, there's more strings attached which allows you to have greater accountability on whether or not the money is going to be spent appropriately. And in terms of a grant, you just got to make sure it gets into the right hands and it's used for the correct purposes. So both of them have important accountability measures in them just a little bit tighter when it comes to loans.
Royce Mendez: I want to pick your brain further on the decision making process around some of these issues that come up around budget time or in this case, around the fall update time. There remain a number of issues, child care and pharmacare included, that are still to be addressed. You mentioned that. Can you give us maybe some insight into how governments tend to grapple, introducing new long term programs, but also having to find a way to pay for it and by pay for it? I don't mean raising revenue. It could be through anything, through deficits, through higher taxes or through spending cuts. How do you see it normally playing out? And has the pandemic changed the way that governments think at all?
Lisa Raitt: I think it has. So we'll start with the last part of your question. First, has political federal party thinking around what our traditionally provincial matters like health, like long term care, like child care? Has it changed? And I would say it has. If you go all the way back to Martin and you go back to health ministers and finance ministers, like with Minister Flaherty, the point that was always approached was, look, we're going to provide you with X amount of dollars for your health care. And we believe the provinces are in the best place to make the decisions around the health care. What the pandemic has pointed up is that there are some gaps in the system and through no fault of the provinces, there's no blaming going on here. It's just a reality that we have some significant gaps. Then as a result, the gaps need to be filled. I listen to the leader of the Bloc Quebecois, after the presentation of the document yesterday, and what he said was this is an insult to Quebec because you're trying to tell Quebec what to do and that's not your job. Your job is just to hand over the points or to hand over the tax points or to hand over the money so that they can make the best decision for Quebecers. I think you'll hear that from across the country. So setting up these advisory panels, which will include provincial input, I believe. They will help guide us in terms of figuring out the best way forward on these on these kinds of issues, Saskatchewan may take a completely different approach on how to deal with child care, given that they are so geographically dispersed as opposed to Toronto, which may take a very different approach on child care. And that all has to be taken into consideration. And in the meantime, what you'll note is that the liberals certainly haven't said we're just going to do this committee and try to figure it out. What they have done is they've actually increased how much child care benefit is going to be available to people as a result of pandemics. So that number went up again and it's going through the 2020 / 2021 books as well. So they're saying, yep, we've got to figure out the child care, not only from the point of view of it was a gap in the pandemic, but we need to get people back to work and child care is going to be an important part of it. But secondly, that we're still going to be there to look after the people who are vulnerable as a result. So they struck the right balance. Now, the key is this. How are they going to thread that needle of providing universal day care across the country? Or even if that is something that's still wanted? And we'll have to wait and see what this this Blue-Chip panel comes up with over two years. It's a significant amount of time.
Royce Mendez: I don't think anybody envies the position policymakers are in at the moment. Thank you, Lisa. It is always a pleasure to have you on the show. Now, I want to bring in my usual co-host, Ian Pollick, global head of fixed income, commodities and currency strategy here at CIBC Capital Markets. Ian, Welcome back.
Ian Pollick: Thanks. That was a great discussion between you and Lisa.
Royce Mendez: So I actually want to ask you about the government debt management strategy that was also in the report earlier this week. Was there actually anything new in the strategy that you saw?
Ian Pollick: Yes and no. I mean, as a starting point, we weren't exactly sure we were going to get any issuance update. And in the event, we did get a mini section dedicated to the medium term debt strategy. And in the document, it was interesting because what we've seen recently is the government has been reducing the size of auctions in twos, threes and fives. And really we thought that was a function of cash balances that were sitting at the Bank of Canada were getting quite large, and that's partly seasonal. They weren't being paid down quick enough. Cash wasn't leaving the door fast enough. And I think the cash buffer that was required at the very start of the crisis is no longer needed to the same degree as today. But what we also saw in the microdata was that from a revenue perspective, corporate income tax revenues have been increasing. So net net, we had thought that the reduction seen over the past six weeks in issuance would eventually be made up in the later months of the current fiscal year. But in reality, what we saw in the debt management strategy yesterday was an indication that, in fact, no lost issuance are lost for good, meaning that the government has decided to reduce twos, threes and fives relative to the baseline DMS outlined in July. And in fact, when you look at full year bond issuance, which was planned originally at four hundred nine billion, the government now sees full year bond issuance at three hundred and seventy four billion. And again, these are just Top End estimates. So it's not likely that you always end up reaching this. And that's important because that's roughly thirty five billion lower than expected. Now, the other twist here is that while they did reduced bond issuance, they effectively took what they removed from term coupons into the bills market. And that's really interesting for a government that's talking about terming out the debt. They're effectively now moving a lot of that debt very short term and relying on the longer term issuance in the back end.
Royce Mendez: How does this play into the Bank of Canada's quantitative easing program? We've talked about previously on this show that there is the possibility that if the government is terming out its debt at the same time, the Bank of Canada is trying to buy up long term debt and push down rates, they're sort of rowing in opposite directions. But it seems like we're seeing a little bit of a change here. Am I right to say that?
Ian Pollick: I don't know. I hate agreeing with you in the best of times, but this time I think I generally disagree. And I'll tell you why. It's I think, you know, when you look at what the Bank of Canada is trying to do with their QE program, they're turning out of their QE is really just more purchases of five year bonds, 10 year bonds and to a lesser extent, 30 year bonds. So when we do look at the proportional increase that we've seen in the weekly QE operations, your biggest increase proportionately came from the five year sector and then, not surprisingly, the 10 year sector. And there's a little bit of less reliance on that 30 year part of the curve. At the same time, you are kind of correct that you are rolling in different directions because the bank, or the government, I should say, is trying to issue much longer term. But once of the things that we talked about last week after Governor Macklem's discussion was that there was this hypothetical line in the sand drawn, once you get to that 50 percent level of ownership from a central bank, marketliquidity and functioning becomes impaired. If you do the math, all that's really happened as a result of that nearly 40 billion reduction in bond issuance is that it gets you incrementally closer to that line in the sand. And just to put some numbers out there, today the bank owns thirty four percent of the market. By the end of the fiscal year and March twenty one it will now own thirty nine percent of the market versus thirty six percent before. And by the end of 2021, you're now at forty eight and a half percent ownership of the market, assuming that we don't get any more changes in the estimated deficit for twenty one twenty two. To me that really opens up this interesting situation where as you get closer to that kind of mythical line in the sand, if it's real and if it's binding, then the bank is going to start to think about what to do in terms of reducing QE, and that really raises the probability of a taper at the same time. What does really support your earlier question is that in the DM's yesterday or two days ago, they said that a 50 year bond maturity would likely play a more permanent spot in issuance rotation next fiscal year. You marry those things together. That still leaves you with a much steeper profile for the yield curve. But I'd be curious to think, given what I just said, A, do we believe this 50 percent number and B, within the context of stopping QE ahead of the economy, closing its output gap and sustainably reaching that two percent target, are we in for a situation where in the Q4 of 2021, suddenly we get an exit strategy introduced?
Royce Mendez: Well, first of all, on the 50 percent, the way I interpreted it is he mentioned it within the context of other central banks saying that there was this threshold between 50 and 70 percent where you start to see an impairment in bond markets. So I don't think it's such a clear line in the sand. Secondly, you mentioned the proportion of debt that the Bank of Canada will own by the end of 2021. But the hope is that by the end of 2021, the economy is on significantly better footing. There is mass vaccination of Canadians and we are on the path well on the path towards something that looks far more normal in terms of an economy. And that seems to be the types of conditions that would warrant a taper in QE. What I will say and maybe you'll disagree with this, is that I don't think we should be too worried in a country like Canada that it could lead to a taper-tantrum like we saw in the US. Of course, quantitative easing in in this country is far less powerful. Bond yields are far more susceptible to global yield movement. So I would be more concerned about when and if the Federal Reserve exits its QE program too early. Would you agree with that or disagree?
Ian Pollick: I would probably dis- Just kidding. I would probably agree with that. Really we've talked about this many times. It's that Canada is a very small, open economy and therefore the bond market takes a disproportionate amount of price discovery from other larger bond markets, particularly the US rates market. And you could see a Canadian style tantrum, but it's not one that would be anywhere close to the magnitude that we saw in 2013 when the Fed misspoke about its intentions around the balance sheet. What I get concerned about is what happens if you don't get that announcement from the Fed that they're tapering and yet you do get much better macro trajectory in the second half that takes yields higher. That's a situation where all QE in Canada is doing is reducing that cross market sensitivity. So it could be a situation where, yea you could see actually a very large tantrum that's really more characterised as catching up to where global yields already are. If we are in a situation as per our recently released rate forecasts, where we do see rates 50 to 60 basis points higher in the long end. And I think where I get a bit concerned and I'll turn this over to you. When we think about rising interest rates and we know that at least in the very short end, Canadian rates are the highest in the G7, in the back end, we're still well through the United States. But the scenario that we're talking about does start to engender some strength in the Canadian dollar, which, as we talk right now is at a near three year high versus the US dollar. We saw in the GDP report yesterday that one of the main negative sectors contributing to the downside print was net trade. So if we're talking about potentially higher longer term interest rates and higher short term interest rates, and that leads to a stronger Canadian dollar, does that reduce our growth outlook or forecast in 2021?
Royce Mendez: Well. I was going to end the show on a high point where we broadly agreed, but you asked another question, so here we go. I think that for at least the next year or so, the focus for the Canadian economy really needs to be on household. So first, getting Canadians vaccinated and getting Canadians living life, that looks more normal, that will get household spending looking more normal, and that will get overall the Canadian economy looking more normal. It may not get us all the way back, but it will get us to a point where the economy resembles something like the pre covid-19 economy. Then I believe we will start to worry again about the lack of traction that we've talked about for so many years in things like fixed business investment and exports. But until then, really, the first leg of this recovery from here on out needs to be the household getting back out and about spending money on services. And that's going to really lead the way from this point. Look, I think we've covered a lot of ground here.
Ian Pollick: Except for the question that I just asked because you literally didn't answer.
Royce Mendez: What was the question?
Ian Pollick: Question was in a nutshell.. "Look, it's me in a nutshell".. What do you think about Canadian dollar strength within the context of our current growth outlook? It's not really a situation that is beneficial in the early stages of the normalization phase. So, I mean, are you worried about the Canadian dollar right now?
Royce Mendez: I said all those things about focusing on the household. I meant to say that, no, it's less concerning in this context than it would normally be, because a lot of what we are really focused on in the moment is getting households back in a position to spend in ways that they did pretty covid. So that's on a certain mix of goods and services. The level of the Canadian dollar in that context is less important. So, it is not really changing our overall view of near-term macroeconomics, particularly pre-vaccine. I will say over the medium term, our view remains the same. That is that the level of the Canadian dollar or dollar Canada, where it is around today at one 30, is too strong to engender the type of growth in exports needed for that sort of escape velocity and to get associated business investment going. But to answer your question a second time, the answer is no. The Canadian dollar is not really concerning us at the moment. That's not really changing our view of the economic outlook. So why don't we wrap that up?
Ian Pollick: Yes. Why don't we wrap it up and say adieu to all of our listeners. Royce, Lisa, thank you very much for an amazing episode. And remember, no bonds were harmed in the making of this podcast.
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