Investors are perturbed with Bank of Canada boss Stephen Poloz. The central bank's decision Wednesday to retreat from its long-standing promise of eventually raising interest rates (its so-called "tightening bias") signals bottom-of-the-barrel policy interest rates from the bank for a long time to come. To many, that dashes their hopes of improving yields in the financial market.
But with all due respect, you're looking at the wrong guy. Ben Bernanke is your man.
Mr. Bernanke, the head of the U.S. Federal Reserve, triggered the surge in bond yields that began in May, when he first suggested that the U.S. central bank could begin reducing its quantitative easing (QE) program of asset purchases as early as the fall. The anticipation of this so-called "tapering," which would represent the beginning of a long process of tightening monetary policy that would eventually include the raising of central-bank interest rates, sent the U.S. 10-year Treasury bond yield up more than 135 basis points, to the brink of 3 per cent by early September. (A basis point is one-hundredth of a percentage point.)
This spike in market interest rates wasn't just a U.S. phenomenon. Global bonds, including Canada's, responded in kind to the prospect of the Fed shifting into tightening mode. Canada's 10-year government bond yield surged 115 basis points from early May to mid-September, peaking above 2.80 per cent.
Remember that this came at a time when the Bank of Canada was actually backpedalling on its own rate outlook. In the central bank's policy statements of January, March and July, it took successive small steps to ease the language surrounding its tightening bias, each time signalling that eventual rate increases were more distant and less certain. Clearly, the rise in Canadian bond yields did not stem from what the domestic central bank was saying; the Canadian market was under the Fed's tapering spell.
And what happened when the Fed decided at its mid-September policy meeting not to begin tapering after all? Since then, the U.S. 10-year yield has backtracked 35 basis points – and Canada's 10-year yield has matched it point-for-point.
There's no reason to expect this to change in the coming months. We're approaching a critical turning point in Fed policy that only comes once in each global economic cycle; it is going to hold sway over global financial markets, including those of Canada.
For Canadian investors, the future of market interest rates over the next six to 12 months is likely to be determined much more by what the Fed decides than what the Bank of Canada says. If the Fed were to announce later this year that it is beginning tapering (such an announcement at its October policy meeting now seems unlikely, but the December meeting is still a possibility), that could resume the march upward of global bond-market rates, Canada's included.
Indeed, the financial markets' laser-focus on Fed policy may be as compelling a reason as any for the Bank of Canada to abandon the tightening bias. As Bank of Nova Scotia economists Derek Holt and Dov Zigler point out in a report Thursday, Canada's still-overstretched household sector is in a poor position to weather an interest-rate shock brought on by Fed tapering. The Bank of Canada's most prudent move might be to stick to a more dovish stance – to lean its policy against global rate pressures and cushion the blow for Canada.