September 24, 2021 | 12:40
As equity markets were faceplanting Monday morning on Evergrande concerns, how many were thinking: “Why, I do believe that rising bond yields will be the big financial market story this week”? Show of hands… anyone… anyone… Bueller? Bueller? Yet, after hitting an air pocket on Monday, markets bounced back across the board, with sturdy gains in equities, commodities, and, yes, bond yields. U.S. 10-year yields reversed almost 15 bps to the 1.45% level, while 5s hit 0.95%, or close to the highest level of the pandemic. It was a similar picture in Canada, where the 5-year yield punched above 1%, matching its highest level since Feb/20.
Seemingly everyone has their own favoured explanation for the sudden and notable back-up in yields, which unfolded in earnest roughly 18 hours after the FOMC announcement. And to some extent, a dissection of those explanations provides a nice recap of this week’s major economic events:
Bringing these strands together, we would opt for the explanation that bonds sold off on the dawning realization that central bank policy is now steadily turning less loose, driven by mounting inflation concerns. From a bigger picture, 10-year yields have simply returned to the underlying upward grinding trend in place since the middle of last year. Those yields got well ahead of themselves early this year, on optimism of a rapid snap-back in activity, and then fell back on the reality of a more drawn-out global recovery. But even with the numerous challenges, we do believe that the recovery is still moving forward, and that yields, too, will slowly revert to something closer to ‘normal’ over the next two years. From our perspective, that points to a 10-year Treasury yield of around 1.5% at the end of this year and closer to 2% by end-2022, with GOCs following largely in tow.
We delve more deeply into the fiscal implications of this week’s Canadian federal election in the Feature (page 8). But a key message is that while the results were almost a carbon copy of the 2019 vote, it nevertheless points to economic changes. Namely, a further ramping up of spending plans, partly funded through a variety of new revenue measures. As an aside, this potentially fundamental shift was determined by an incredibly small portion of the population. After all, the voter turnout was relatively low (only a bit above 60%), and the winning party had a record-low vote share (less than 33% at last count). In other words, that’s less than 20% of the adult population who voted for the Liberals. Broadening that theme, they garnered just over 5.5 million votes in a total Canadian population (including kids) of just above 38 million. So, a grand total of 14.5% of the populace voted for the ruling party, or about 1 in 7 people. A clear mandate indeed!
One word of warning before attaching much importance on any new fiscal forecasts: Treat with extreme caution. The latest official figures from Ontario for FY20/21 provide a clear example. Final public accounts for the province, released just today, reveal that the deficit was $16.4 billion—or a cool $22.1 billion less than the $38.5 billion expected in this year’s budget. So, instead of a meaty shortfall of 4.5% of GDP last year, the gap was instead a bit below 2%, a much less problematic level. The massive miss was attributed to much better than expected revenues. Please keep in mind this gargantuan misfire on the budget balance estimate for the year just past, when analysts are quibbling about fiscal projections five years down the road.