This is the way

Disclaimer: The materials disclosed on this podcast are deemed to be sales desk literature and subject to our client communication policy and code of conduct as well as IIROC rules.

Ian Pollick: Super courageous, buddy. Super courageous.

Jeremy Saunders: I think the market is right. I think it’s reasonable, like the Fed could do 50, they could go every meeting like they seem, they seem much more shook.

Ian Pollick: So before we begin today’s episode, I just want to say one thing. The call going into the Bank of Canada yesterday, it was an exceptionally difficult one, and I think all of my counterparts on the street did a fantastic job in defending their views in justifying their forecast. Now there’s a very small number within this analytical community that have suggested that those of us who ended up on the right side of the decision or right for the wrong reasons. So in the spirit of community, I would just say this we work in this seat with imperfect knowledge, and having humility is an incredibly important aspect of the job. Now the airing of grievances is done. Jeremy, you are a co-host this week. For those of you who don’t know, this is Jeremy Saunders, executive director on our XVA desk. You were on the show a really long time ago, but welcome back man.

Jeremy Saunders: Ian, thanks for having me.

Ian Pollick: Yeah, of course. So listen, we got to start with the obvious. The bank yesterday, the Fed yesterday. What do you want to start with? Dealer’s choice? Let’s start with the bank. Ok, so you know, obviously you look at the hawkish hold, which actually kind of look like a hawkish hold. Let’s talk about the forecast for a second. You know, it looked at the forecast CPI higher growth, a little bit lower. Potential growth was actually revised a little bit higher. When you look at the forecast, when you look at the MPR. What stood out to you?

Jeremy Saunders: Yeah, I mean, I think the thing that stands out to me is the near-term forecast for inflation. I know we talked about this a little before. My sort of grandiose theory here is that, you know, we’ve seen a hawkish pivot from the bank. We’ve seen a hawkish pivot from the Fed. They both still think inflation ultimately will come down on its own. And they both think to a large extent, the inflation we’re seeing right now they can’t do much about. And I think the biggest thing that they’re concerned about is expectations getting on anchored. And so to me, I see them as this is a bluff. They are turning hawkish, they’re talking down expectations and they expect that ultimately they won’t have to hike as much as what’s priced into the market. But they’re happy having the market price it in right now and keeping expectations tamped. And so when I see five point one percent on the CPI forecast, I think that actually gives them a lot of room to undershoot and it’s going to be difficult for them to overshoot. That’s going to set them up for underperforming what’s what’s priced into the market right now. But I think that’s the thing that stood out the most to me.

Ian Pollick: Ok, so there’s a lot to unpack there. Let’s just start with the first and foremost. Why do you think they didn’t go yesterday or two days ago?

Jeremy Saunders: I had thought they would go, so I was a little surprised. But I agree with you that it was a real tough call. I thought it was basically 50 50 and why I think they didn’t go. Ironically, they are trying to maintain credibility. I know there’s been a couple commentators in the market out there saying that this hurts their credibility and I think the way they see it is to them. Ultimately, the difference between them hiking in January or hiking in March, they think leaves them at a at a policy rate that’s pretty similar by mid-year. And so, you know, forward guidance works if the market believes it and doesn’t work if it doesn’t. And for them going from having the guidance in the statement to removing it and hiking in the same meeting, I think that actually they’re looking much further down the line and say the next time we need to use this is going to believe us.

Ian Pollick: So you lose the credibility. So like, that was one of the things we thought about, and that’s really what the expectations communication argument was all about. Like, you know, you told us middle quarters of twenty twenty two, you didn’t speak to us for six weeks. All of a sudden you’re going to hike rates. So I think they actually did a really good job in terms of preserving it for the future. Other than that, though, you know, when you look at some of the assumptions in the MPR, you know, the output gap put in a really big performance like they have the output gap now at minus three quarters to plus a quarter. That’s one hundred and fifty basis point improvement from Q3 at a time where it looks like Q4 growth is only going to mildly come in close to their expectations. You know, I guess for you, let’s get back to what you were saying earlier. You don’t think that they’re going to be able to beat the forwards in terms of market pricing. As a bank, we’re looking for four hikes now. You know, we change the forecast as of two days ago, March start, April start, we think March, April, July, Oct. That’s it for the year. If I had to ask you to give me your distribution of hikes, where are they?

Jeremy Saunders: Yeah, I think I think they’re going three of the next four. And whether that’s hike, hike, hold, hike or hike, hike, hike, hold, I think they’re going three of the next four. And then I think that I agree with you. I had four actually just bet our our local Friendly’s star trader a beer that that they were going to that they were going to realise for. But it’s a pretty, pretty skewed bet, I think, for him. So he’s only getting a domestic and I and I get it. Yeah, I get I get an import if it’s for so.

Ian Pollick: Well, let’s talk about this for a second. If you do think that they’re going three of the next four meetings, it is almost impossible to reallocate the distribution or the profile of twenty twenty two hikes until much later in the year. So if you believe that, then isn’t the whole problem around this idea that spreads have to be lower in the front end, a function of cash catching up to OIS, but if OIS does. Move, then, you know, what is the.. Does that trade still make sense?

Jeremy Saunders: Yeah. I mean, I don’t know if I’m a I’m a real believer of the two years spread trade at this point. I think like if you go back in time, I know you had a piece out with a chart of it and see your cash tends to track like, you know, you can pick whatever you want, but like some kind of near term OIS expectations like I have one year, one year forward, three month OIS up on my chart and it tracks real well and it’s gotten it’s gotten real out of whack. And it’s just the bank owns too many bonds. And I think, you know, we’ve heard the bank and the Fed both say in the last few days that the sheet is not is not their cool, right? Like they’re hiking rates. They’re not they’re, you know, the Fed said they haven’t even started to think about what the exact contour of of the sheet runoff looks like. Like we’re just collateral is going to be scarce, and I don’t see how that fixes itself for a while. And so I think like, you know, you can play the two year spreads for carry on the short side, but you’re going to get squeezed every now and then, and I don’t see how it resolves it. You know, they’re going to have to issue bonds.

Ian Pollick: Well, it’s interesting. It’s that, you know, you kind of look at the plumbing in the short end. And over the past two days, we’ve seen JC set lower, CORA asset. Lower spreads are wider. So I think the initial contours of the silhouette of your thesis is coming through But you know, I wonder in the near term, you know, when we think about the balance sheet for the Bank of Canada, we put out a piece on it a few weeks ago. I think they go almost right away. So they hike in March. I think by the April MPR, they’re excluding the reinvestment phase, and I think they’re just starting to let bonds roll off. I know you have a bit of a different view, so why don’t you enlighten us what that is?

Jeremy Saunders: Yeah, I mean, I don’t disagree. The View. I just think that it’s a question of of what does that move? Does it move twos or does it move like, you know, three month bills? And I think it can move three month bills and you can get some of the some of the repo squeeze comes off. But like the reality is, what’s what’s rolling off is not two year bonds not being replaced with two year bonds. It’s like money market paper. And it’s, you know, you just got like a segregation of participants in Canada. Maybe you know your your past life as a as a candidate trader, you might know better than me. But my my view of it is like the guys buying three month paper and the guys buying a two year coupon are just not the same.

Ian Pollick: Yeah, no, I hear you. I want to move over a bit because obviously yesterday we had two days ago was Super Wednesday, you know, whereas the Bank of Canada was very specific, saying that they are taking a decisive series of steps to alter the course of their current emergency measures there. And you know, the governor kept talking about a significant change. You had the Fed and you had the Fed talking about steady, measured pace. Let’s just talk about the Fed for a second. When Powell was in the Q&A, I could not help but think that he pulled the twenty eighteen. We are miles away from terminal comment. Did you get that feeling or do you think he said what he wanted to say?

Jeremy Saunders: That was the first thing I thought. I think he said that now. I mean, it’s it’s much more warranted now than it was in twenty eighteen like rates. At zero, you got seven percent inflation, you got GDP printing six point nine. Like, it’s not unreasonable. And then the other thing is, what do I supposed to do right? Like people don’t borrow overnight like corps. don’t borrow overnight. Mortgages are not overnight. People borrow five year money in Canada, ten year money in the U.S. The way hikes tighten financial conditions is they get we all retire in the belly, they get credit spreads wider and they get equities lower. Like, if none of those things happen, then it’s not going to tighten. Financial conditions is not going to slow down consumer spending. So we’re in this perverse or maybe not perverse, but we’re in this situation where, like he, he wants that to happen. In some respect, they want a slow bleed and they’re hoping it’s controlled. But like, I wonder if in some respects it’s intentional?

Ian Pollick: Well, I think there’s you know, the downside here is, like you say, like we all know, policy at the best of times is a very blunt tool. And if that blunt tool is not capable of acutely solving this capacity induced inflationary pressures, then all that ends up actually happening is that you may be moving out of this kind of financial repression environment because you have this higher overnight level, you may attract savings back into the system. Therefore, you make investment that much stronger. You have capital deepening and in a really screwed up way, you actually raise our star in the process. You know, this could be a secular shift. I doubt it. But you know, the downside of this actually leads to much higher rates over time.

Jeremy Saunders: Yeah, I mean, this is obviously the this is this is the sixty four thousand dollar question, right? The market’s definitely telling you they don’t believe it. The price action in the last twenty four hours has been all curves go to zero. And I think my big, big brained idea for twenty twenty two is like this. The growth is a show me trade, right? Like the market is going to think we’re in the old regime until it gets proven otherwise and like that. Really, that’s why I don’t think the, you know, short belly is the trade for now. I think the short. It is a trade for June or July, when rates are seventy five beats higher and growth doesn’t tank like that’s when you can sell the belly.

Ian Pollick: Yeah, fair. Ok, so let’s talk about the pace of hikes for the Fed for twenty twenty two CIBCs at four the markets about four, whereas Jeremy Saunders at?

Jeremy Saunders: Yeah, I got to tell you, I mean what I heard yesterday from two different central bankers. I never thought I’d say this, but TIFF was calm and collected and and and Powell kind of felt like he was a little bit unsure like you didn’t really know. Governor Macklem seemed to have a plan. He was executing it. He was not listening to the noise and and the presser for me, for Powell basically said, You know, we we were wrong. We don’t really know what’s going to happen. And now we’re kind of flying by the seat of our pants. And so if I had to guess, I think the Fed’s more likely to to, you know, panic loaded earlier than than the bank. I think the bank is going to go three out of four. And I think it’s unlikely that Macklem goes 50. And and I mean, this is obviously not really super far out from what the market is pricing. But like, I think

Ian Pollick: Super courageous buddy, super courageous.

Jeremy Saunders: I think the market is right. I think it’s reasonable, like the Fed could do 50. They could go every meeting like they seem, they seem much more shook.

Ian Pollick: Ok, so I want to extend this a little bit. But before I do, I had a thought in my head. And I want to ask you, what is the probability in your mind of a non-standard size hike being delivered by either the bank or the Fed in March?

Jeremy Saunders: I think it’s got to be, I’ll say, 30 percent Fed and three percent Bank.

Ian Pollick: Say three?

Jeremy Saunders: I think it’s pretty low.

Ian Pollick: Yeah, no, I get that.

Jeremy Saunders: Ok. I mean what I’m saying. Three. That’s not say zero. That’s as much as I’m willing to hedge. Yeah, exactly.

Ian Pollick: Again, it’s very courageous. Listen, so let’s just talk about that for a second, because what you’re saying before is, you know, the Fed may feel a bit uncomfortable here. They may actually feel very behind the curve, though somewhat evident by Chair Powell’s body language. His narrative, if a front loaded like a fast and furious type of cycle that is front loaded by the Fed, what does that mean for the terminal rate in the U.S.? Because we’ve talked about this for a long time. What the market’s expectation is for terminal or the markets pricing neutral, which are two different things, are still very, very low. And in contrast, we see in Canada that, you know, terminal is still above two percent terminal and Canada has converged with neutral. So there’s two very different narratives happening here. So a why do you think that is? And B, do you think the market’s right or wrong in which market?

Jeremy Saunders: Well, I think there’s a weird interplay between these two things, right? Like the reality is, you know, Canada is beholden to the U.S., right? Our FCI is beholden to the U.S. and and so the faster and the harder the Fed goes, I think the less likely we are to realise what’s priced in Canada right now. The slower the Fed goes, the more likely Canada is to be able to stretch out its cycle. And so I think like, you know, if I had to bet, I bet these things converge over the next little while because I don’t think the market is going to give the U.S. rates complex reprieve until until at least March. So my guess is is, you know, I’ve got so far to year one year one, seventy five, and that’s kind of the peak on the one year curve. I got Canada to in a two and an eight, and that’s kind of the peak on the Canada curve. And so I mean, I like convergence.

Ian Pollick: I think convergence makes a lot of sense, you know, and I think the question is is if if you believe that convergence, right? And if you believe that at some point in your future, you know, what you tend to see over normal cycles is that you get your short term terminal rates, which is like a two year one year, ultimately just meets five or five year, which is kind of your neutral rate. Canada, they talked about the neutral rate yesterday. It’s still two and a quarter midpoint. Is that a soft ceiling for long term rates? When you look at kind of the ten year, 10 years, the 20 or 10 years, all those type of longer dated forwards, they all kind of cap around that level. So what are your thoughts on that relationship binding in the current environment? And if it is, is this just one gigantic flatten or is there any reason that this curve has to steep?

Jeremy Saunders: I think it’s all going to zero. Honestly, like why would who’s going to? I also think, you know, twos and fives, it’s a different market than 10s and longs. There’s a lot of a lot of uneconomic players and 10s and longs. You’ve got a lot of people who just got up on funding and now for the first time in two decades, OK to sell equities, buy bonds like I think it’s all giant flatner again until at least March. I think the belly going higher and that’s five year, five year. You know, you’re going to need to see growth after tightening the market just with good reason will not believe it until that happens.

Ian Pollick: Well, you need growth after tightening, but you also need inflation not to be below two percent. And I think you said this earlier in the year, if you want to make money this year, you have to have an understanding. Does inflation settle and not one half to two two to two half or two plus like that is really the only thing. That’s going to drive the cycle.

Jeremy Saunders: Totally, I mean, that’s the bet, that’s the whole thing is an inflation bet.

Ian Pollick: Yeah, it’s right. Well, let me ask you this. Speaking of bets over the next, let’s say, two weeks, what are your favourite traits?

Jeremy Saunders: Yeah, I mean, I think I think Canada has started to go pretty far like, you know, we got six in Canada and given the tone from the bank and you know, the disparity in the data at the U.S., I don’t like to be long a front end anywhere, but I think the U.S. has got further room to run now that trades obviously looks 10 beats less good than it did walking in this morning. But well,

Ian Pollick: I was going to say that differential. You know, it’s plus five right now, like it’s moved a ton. It was plus forty three weeks ago.

Jeremy Saunders: And the bax are slow to react right like the bax is. You know, they spent a couple of minutes this morning, you know, not moving and they’re slow to react. And I mean, that’s another reason I like to have that trade on is this far more people that are going to sell to the U.S. that are going to sell Canada. We’re just we’re just a small market people aren’t looking at. So I like that as convergent and I like flatness. And I mean, these are obvious trades. So I don’t like to have them on and huge size. And and my bigger picture thing is, I think risk is really going to struggle here. You know, you make it that what you will in terms of what you do for fixed income markets. But I think it’s really hard for the belly to sell off while S&P 500 is going down and whipping around. And so I think it’s all be flatner.

Ian Pollick: Well, let me talk to you about something because you know, you sit and you sit in this seat where you have the benefit of seeing a lot of different asset classes. You see a lot of different structural risk. Talk to me about the moves that you’re seeing in equities versus credit because for all intents and purposes, it’s been pretty well behaved. You know, what are your thoughts on that?

Jeremy Saunders: Yeah. I mean, again, I think there’s a lot to do with mandate and sort of I won’t say the credit. The credit market is non-economic buyers, but it’s there’s a lot of cash that has to go to work. And for what it’s worth, you know, we’re coming unglued a little bit here right now. So my expectation is, you know, Chair Powell basically said as long as credit’s OK, then I’m not too worried about equities deflating and that’s like a double dog, dare I think?

Ian Pollick: Well, that is the double dog dare right? Because if you have the move in equities and you have the widening credit, you know, that’s that that is a much more rapid tightening of financial conditions because the offsets been that you still have loose borrowing rates. But you know, against that, I kind of take a step back and say, well, maybe the Delta FCI matters, but the outright level is still very low, like, very low.

Jeremy Saunders: Yeah. So the the weird thing about about, you know, these financial condition indexes is like, you can look at the weightings. And if you if you go look at the weightings, it’s like 40 percent 10 year rates and forty five spreads, and it’s like four percent or five percent, you know, front end front end rates and four or five percent equities per per basis point of change. And you go, Wow, you know, equities don’t really matter. Yeah. Well, equities can move 1000 basis points rates and credit are not going to move a dozen basis points. So actually, all the contribution when you go pull up, you know, Goldman Sachs Financial Conditions Index in Bloomberg, that whole downward draught is equities. And so if you’re going to unwind that in equity land, you’ve got a long way to go. I think that the speed of credit will will scare central bankers more because that’s more about, you know, market functioning, people being able to roll over debt. And those are the ghosts that they that they see behind bushes but CDXIG we’re 60 to like. We’re 20 beats from all time lows. So it’s really tight. It’s still everything’s still really tight. And I think like there’s been, you know, this conditioning of the Fed is there and the put like the main takeaway from yesterday is just to put. It’s just way lower

Ian Pollick: Strike is deeper out of the money, right? That’s that’s the bottom line. Deeper, way deeper. Ok, speaking of way deeper, we’re heading into the weekend, Jeremy. We really appreciate you coming on the show. Thank you very much. Remember, we’re still looking for a new co-host. You know how to vote? Get in contact with me. Have a great weekend. And remember, there are no buttons harmed in the making of this podcast.

Disclaimer: The information and data contained herein has been obtained or derived from sources believed to be reliable, without independent verification by CIBC Capital Markets and, to the extent that such information and data is based on sources outside CIBC Capital Markets, we do not represent or warrant that any such information or data is accurate, adequate or complete. Notwithstanding anything to the contrary herein, CIBC World Markets Inc. (and/or any affiliate thereof) shall not assume any responsibility or liability of any nature in connection with any of the contents of this communication. CIBC World Markets Inc. or its affiliates may engage in trading strategies or hold positions in the issuers, securities, commodities, currencies or other financial instruments discussed in this communication and may abandon such trading strategies or unwind such positions at any time without notice. CIBC Capital Markets is a trademark brand name under which different legal entities provide different services under this umbrella brand. Products and/or services offered through CIBC Capital Markets include products and/or services offered by the Canadian Imperial Bank of Commerce and various of its subsidiaries. For more information about these legal entities, and about the products and services offered by CIBC Capital Markets, please visit www.cibccm.com. Speakers on this podcasts are not Research Analysts and this communication is not the product of any CIBC World Markets Inc. Research Department nor should it be construed as a Research Report. Speakers on this podcast do not have any actual, implied or apparent authority to act on behalf of any issuer mentioned. The commentary and opinions expressed herein are solely those of the individual(s), except where the speaker expressly states them to be the opinions of CIBC World Markets Inc. Speakers may provide short-term trading views or ideas on issuers, securities, commodities, currencies or other financial instruments but investors should not expect continuing analysis, views or discussion relating to these instruments discussed herein. Any information provided herein is not intended to represent an adequate basis for investors to make an informed investment decision and is subject to change without notice. CIBC World Markets Inc. or its affiliates may engage in trading strategies or hold positions in the issuers, securities, commodities, currencies or other financial instruments discussed in this communication and may abandon such trading strategies or unwind such positions at any time without notice.