OTTAWA ? Recent moves in Canadian markets claim that investors see increased odds of a recession this season and also the potential for “dramatic action” from the Bank of Canada.
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An ominous signal has been cropping up previously month as corporate bonds and government of Canada bonds have seen their spreads widen, a move that always precedes an economic downturn. Meanwhile, yields around the five-year Government of Canada bond have begun creeping below the central bank’s overnight lending rate of 0.5 percent. On Tuesday, they traded at roughly five basis points below that mark.
Canadian stocks are another section of weakness, using the S&P/TSX Composite Index once more slumping right into a bear market on Tuesday. The TSX closed down 2.02 percent, or 252.75 points, to 12,282.65, now down a lot more than 20 percent because the highs of September 2014.
“Looking at the signals in the financial world there are a number of recession indicators which are flashing indicators,” said Mark Chandler, head of Canadian fixed-income strategy at RBC Dominion Securities.
This is real, there is something happening here
The last time short-term bond rates inverted this wild across the curve was in the first 1 / 2 of 2015, which wound up turning into a technical recession – defined as two back-to-back quarters of monetary contraction.
In a normal bond market, longer-dated bonds have higher yields as investors demand more compensation to lend money for an longer timeframe of your time. When multi-year bonds move underneath the overnight rate – the interest rate the Bank of Canada charges banks to give loan to each other for a day – it means investors expect the overnight rate to go lower in reaction to a weakening economy.
Corporate spreads have also been widening in Canada for a lot of the last Twelve months, but for the most part that was because of progressively more distressed energy companies. Chandler says that the widening has spread to non-energy companies too.
“This is real. There is something going on here,” he said. “Usually one of the most powerful indicators is widening of credit spreads, and that’s happening not only to the power sector, but also more broadly.”
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Canadian banks, among the most exposed companies towards the domestic economy, have grown to be one of the big drags on the TSX Composite Index. On Tuesday, the biggest banks, including the Royal Bank of Canada, Toronto-Dominion Bank and Bank of Quebec, saw their shares dip a lot more than two per cent.
Craig Basinger, chief investment officer at Richardson GMP Limited, notes that some Canadian stocks are actually trading at “recession-type” valuations. The banks, for example, exchange the only digits or close to it, with dividend yields creeping into the four and five percent range.
Basinger said the pricing suggests investors are seeing more pain on the horizon.
“Yes, we could certainly see a small recession here company, oil costs are below $30 a barrel again, but valuations have grown to be compelling,” he added. “If we enter an economic downturn, well, the costs are already there.”
The indicators in financial markets come as the Bank of Canada left its overnight lending rate unchanged during its policy announcement last month. Governor Stephen Poloz asserted he was waiting to see the scale of stimulus from the authorities prior to making moving. Your budget, which will outline stimulus details, is expected to land between March or April.
The Bank of Canada also noted there are early indications the non-energy segment from the economy is rebounding as low oil prices along with a weak loonie make exports more competitive. Non-energy exports helped close the trade deficit down to $585 million in December, an unexpected to economists who had expected the trade deficit to develop from $1.6 billion in November to $2.2 billion.
As well, January’s employment report demonstrated that, while oil-dependent provinces for example Alberta, Saskatchewan and Newfoundland and Labrador still bleed jobs, non-energy provinces are booming. Ontario has added 100,000 new jobs in the past Twelve months, while British Columbia and Quebec have also posted healthy job gains.
“Growth remains positive away from oil-rich provinces, supported by an upturn in exports and steadier consumer spending and residential sales,” said Sal Guatieri, senior economist at BMO Capital Markets in the bank’s latest economic outlook released Feb. 5.
Still, Guatieri expects that the Bank of Canada will a minimum of proceed to cut its benchmark rate by 25 basis points to its post-recession low of 0.25 per cent between the spring.
Chandler of RBC said that investors should seriously consider the bond market in the coming weeks. If short rates move off current lows, then it is likely the financial institution of Canada is going to be less dovish. But an extended duration of inverted yields could signal more drastic action.
“I think with such short-term rates – where we’ve five-year yields now below 50 basis points – in order to justify those for a prolonged time period, the marketplace is certainly pricing in high chance of some pretty dramatic action by the central bank,” he said. “Whether it’s negative rates of interest or possibility of QE, it’s hard to justify the present yields without those expectations.”
jshmuel@nationalpost.com
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