04 Nov 2022

Has the Bank of Canada made you a Belieber in a policy pivot?

By Christopher Jeffery

Encouraging words from the BoC governor led to a rally in Canadian bonds. Are we seeing a slow-motion dovish pivot unfold among developed market central banks?


Canada is not necessarily renowned for being a trend-setter. In music, it’s the country that has given us Justin Bieber, Celine Dion and Shania Twain. In fashion, it’s the home of the double-denim ‘Canadian tuxedo’.

However, in the staid world of central banking, Canada has been a leader in this hiking cycle. The Bank of Canada (BoC) started raising rates ahead of most of the rest of the developed world and is, so far, the only G7 central bank to have delivered a supersize 100bps hike.

50bps? That don’t impress me much

Hints of a pivot unfolding in Ottawa last week are, therefore, significant. The BoC hiked by 50bps when a bigger hike was widely anticipated and talked down the risk of further aggressive steps.

BoC governor Tiff Macklem was keen to remind the markets that “This tightening phase will draw to a close. We are getting closer, but we aren’t there yet.”

In the words of Celine, the market implications were felt “near, far, wherever you are”. A selloff in the Canadian dollar and a rally in Canadian bonds followed.

The case for a policy pivot mounties up

The second of those developments has prompted investors to ask the million / billion / trillion dollar question: will other major central banks will follow suit? Could the much-anticipated US Federal Reserve (Fed), European Central Bank (ECB) and Bank of England (BoE) policy pivot finally be drawing near?

Listening to these institutions’ chiefs Jerome Powell, Christine Lagarde and Andrew Bailey this week, the answers are “maybe”, “probablement” and “perhaps” respectively. Despite the fact that all three central banks increased their policy rates by 75bps, there were hints that the days of aggressive rate hikes are now behind us.

The Federal Reserve’s message is: “In determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.” In plainer English, that’s a statement that rate increases may slow down from here, but markets shouldn’t get too excited about an imminent end to the hiking cycle.

In Europe, the ECB’s story is similarly nuanced: “We have made substantial progress in withdrawing monetary policy accommodation… Our future policy rate decisions will continue to be data-dependent and follow a meeting-by-meeting approach.”

And back in Blighty, the Bank of England told us: “Further increases in Bank Rate may be required for a sustainable return of inflation to target, albeit to a peak lower than priced into financial markets.”

The common starting point is that money market curves anticipate more rate hikes to come, but at a slower pace: 125bps over four months in the US, 150bps over six months in the Eurozone, and 175bps over 12 months in the UK. We’re confident that puts policy well into restrictive territory in all three cases. The implication is that interest-rate sensitive parts of the economy will start to feel the pain with housing first in line.

What aboot the housing market?

But there’s pain, and there’s pain. As Hetal’s recent blog highlighted, this is where Canada stands apart.

As interest rates have risen, the squeeze on property has been severe, with nationwide house prices down nearly 10% since the peak of the Canada Real Estate Association Index. That’s a harsher turnaround than almost anywhere else in the world. Given the importance of housing turnover in sales of durable goods, of housing wealth in consumer spending, and of housing construction in employment, this is a very good reason for the BoC to pivot earlier than most.

We expect similar, albeit less dramatic, developments elsewhere with rates now restrictive. As growth – and housing markets – around the world slow, we become more confident that the end of the rate-hiking cycle is drawing near. Former Fed Governor Jeremy Stein observed in 2013 that tighter monetary policy “gets in all the cracks”.

As anyone who has struggled with subsidence issues will know, housing is vulnerable to cracks when put under sufficient external pressure.

In terms of investment implications beyond those housing concerns, we think this slow-motion pivot is a reminder that we shouldn’t throw out the bond baby with the inflation bathwater. As the global aggregate supply shock morphs into a policy-induced downturn in aggregate demand, we believe government bond yields are likely to find a firmer footing. Assets that typically do well in the face of a sudden downturn in growth are hard to find, and we shouldn’t lose sight of this important role played by the bond market in investor portfolios.

Indeed, when contemplating the outlook, it’s worth remembering that Treasury yields have fallen during 17 out of the past 18 US recessions.

Christopher Jeffery

Head of Inflation and Rates Strategy

Chris works as a strategist within LGIM’s asset allocation team, focussing on discretionary fixed income and systematic risk premia strategies. He coordinates global rates and inflation strategy across LGIM’s asset allocation and fixed income capabilities. He joined LGIM in 2014 from BNP Paribas Investment Partners where he worked as a senior economist and strategist within the Multi-Asset Solutions group. Prior to that, he worked as an economist within monetary analysis at the Bank of England with a focus on the UK domestic economy. Chris graduated from University College, Oxford in 2001 with a first class degree in philosophy, politics and economics. He also holds an Msc in economics (research) from the London School of Economics and is a CFA charterholder.

Christopher Jeffery