New round of inflation fears as investors demand higher rates
Spring home-buying binge adds risk to worries over coming rise in borrowing costs
Amid a frenzy of bidding wars, Canadians hunting for a home may be unlikely to spare a glance at what is, to most, an obscure statistic buried in the business pages this week.
In Canada's hot real estate market, a tiny change in borrowing costs is likely the least of a house-hunter's current worries. But the rise of a key bond interest rate to levels not seen since well before the pandemic is another hint about the potential path of interest rates and the direction of long-term inflation.
Since I wrote last July about the prospects for a new round of inflation, referring to it as a "contrarian" perspective, a number of economic commentators have begun to concede that an era of 40 years of stable prices could be coming to an end. That doesn't mean it's so. But it does mean people are more sensitive to signals that inflation may be on the rise.
It also means that people are watching very closely for what central banks say, and what they do, that could influence interest rates in the long term.
They are also watching the bond markets.
The bond rate that is attracting attention this week is called the U.S. ten-year Treasury. Considered one of the safest investments on earth because they are backed by the government of the United States, investors are willing to pay for that safety by accepting low interest rates. That means the bond sets a global standard for low rates. More risk demands a higher interest rate.
(As I have explained in previous columns, what we ordinary folks call "interest rates" the bond market calls "yields.")
There are a number of ways of framing it, but one way of describing what is happening in the bond market is that traders see a boom ahead.
"Coronavirus vaccine rollouts and planned infrastructure spending boosted expectations of a broad recovery and rising inflation," the business news network CNBC reported on Tuesday.
With growing confidence in the economy, investors are no longer willing to lock in their money for ten years at 0.51 per cent the way they were last summer when they were so nervous about what the future held.
That means traders have been selling those ten-year bonds and only buying bonds that yield something closer to 1.8 per cent. Therefore, the price of those existing lower-interest rate bonds had to fall in value until the returns evened out and the old bonds "yielded" the new higher rate, in what the Financial Times called "a brutal [first] quarter for global government bonds."
Bank of Canada governor Tiff Macklem has warned us about extrapolative expectations in the market for homes, but if you are willing to extrapolate, the above graph of rising Treasury interest rates looks suspiciously like a trend which hints at a coming rise in inflation.
So why are rates rising?
While Macklem has continued to insist the Bank of Canada has no plans to raise interest rates, the bank is widely expected to cut some of its stimulus for longer term debt, rolling back bond buying as soon as next month. Bond buying is meant to hold down market rates, especially over the longer term.
"The Bank of Canada should have taken the opportunity to taper its bond purchases … but it will need very strong arguments if it chooses to pass again in April," Derek Holt, vice-president of capital markets economics at Scotiabank, said earlier this month.
After many signals the economy is on the mend, Friday's jobs numbers in the U.S. are expected to be strong, adding to inflationary expectations. Statistics Canada does not report its jobs numbers until the following week.
Even while saying the U.S. Federal Reserve would keep rates low, on Monday Christopher Waller, a member of the Fed's board of governors, insisted the central bank would not use bond buying to artificially hold interest rates down so the government could borrow on the cheap.
"Because of the large fiscal deficits and rising federal debt, a narrative has emerged that the Federal Reserve will succumb to pressures to keep interest rates low to help service the debt and to maintain asset purchases to help finance the federal government," Waller said on Monday before the bond rates' latest tick up.
As I wrote last July, that is exactly the narrative proposed by some who foresee a long-term rise in inflation. Effectively they say, as paying off the huge current public debt becomes prohibitively expensive, governments and their central banks would have to chose among, "austerity, default or inflation" and that inflation would be the only politically acceptable option.
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Earlier this month Federal Reserve chair Jerome Powell reiterated that inflation, while expected to rise over the next few years would revert to around two per cent because that is what people have grown to expect inflation to be. Sharp rises in central bank interest rates won't be needed.
But as we've seen again this week, U.S. bond markets, widely accepted as leaders for retail mortgage rates, may not care about the words Powell says.
And for Canadians staring into a 25-year future burdened by hundreds of thousands of dollars in mortgage debt, the current trend in the U.S. bond market seems to be telling a different story, of a future that could include a steady rise in rates. But just as with the future price of houses, extrapolating from an interest rate trend is far from foolproof.
Follow Don Pittis on Twitter @don_pittis