1-on-1 With Hank Cunningham
We have abundant respect for traders who stand the test of time. It’s so incredibly hard to be right more than you’re wrong in the financial markets—that is, right enough that you can generate consistent long-term returns. Hank is one of those people.
We spent a little time with him last week to get his take on rates and the Bank of Canada (BoC).
Here are some of the nuggets from our chat…
On long-term interest rates…
Hank: I don’t see much upward pressure on rates—not in the developed world. There’s no inflation to speak of. In fact, inflation continues to recede in most places if anything.
On the European debt crisis…
Hank: The sovereign debt issue is a major problem, but it’s confined to a part of the globe where it’s not going to have a material impact on the rest of the world. Certainly not from a growth point of view.
On long-term rates one year from now…
Hank: You’re going to see a flatter yield curve looking out a year. The spread between a 1-year mortgage and a 5-year mortgage is going to be a lot narrower. The yield curve is still steep right now. I think (mortgage) clients are still better off floating than they are fixing.
One of the other things you have to think about is the amount of debt coming due by governments. The U.S. has 40% of its debt maturing in the next three years. They don’t want higher inflation and interest rates.
On inflation risk…
Hank: Inflation is just under 2% in Canada. In the U.S. it's under 1% actually.
There are 21 central banks with anti-inflation targets that are embedded in their legislation. You know they’re going to raise rates to beat back inflation and demand. It almost defeats inflation before it starts. If the market sees central bankers acting aggressively to control inflation, the long end of the (yield) curve will come down. It becomes a self-fulfilling prophesy.
The good news is that, if inflation does become a problem, the Bank of Canada will accelerate increases in the overnight rate and dampen demand, which is actually bullish for bonds long-term because investors see that the Bank is going to fight inflation.
The 5-year rate might go up a bit, but the market will get anticipatory (and discount the Bank of Canada’s future rate increases)…and then, longer-term yields should come back down. People tend to underestimate the discounting nature of the market.
On a 2.40% to 2.50% floor in bond yields…
Hank: That's going to be huge resistance for price—or support for yields—whichever way you want to look at it. I really can’t envision a situation for yields to drop below 2.40% for five years. This is probably as cheap as rates are going to be.
On economists’ forecasts of the Bank of Canada…
Hank: Economists generally do straight line forecasting. They don’t allow a lot of room for (unexpected) changes in the marketplace. Rate forecasts depend on your view of the world. My view of the world is one of growth with very little inflation. In that scenario there is no need for serious tightening. Market rates will rise if the demand for money rises. The market really acts independently from the Bank of Canada, as you know.
On where we go from here…
Hank: The BoC has already indicated that rates are going up. It (the hike in June) won’t be the last increase in the Bank rate. You’re going to see a flatter yield curve for sure.
The banks have been funding longer-term mortgages with short-term money. They pay nothing on savings and charge 4% for a mortgage. It’s been easy arbitrage. In 12-18 months that will be over.
In the meantime, people with mortgages will be “forced” to fix at the wrong time, right before rates come back down again. It happens, and it’s going to happen again. We’ve already had one false move in rates.
On going fixed or variable…
Money has been cheap. If people have fear of rates rising, you can fix right now and still have cheap money. I have no problem recommending that. But if you’re playing it close to the chest, I would stay floating right now.
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About Hank: Hank Cunningham is the Fixed Income Strategist at Odlum Brown. Hank has more than 40 years of experience in fixed income markets. He has been a trader, institutional salesman, portfolio manager, and zero coupon specialist. Since 1988, he has specialized in the retail aspect of the investment business, building and managing three different retail fixed income trading desks for Dean Witter Canada, First Marathon Securities, and Blackmont Capital.
Hank is the author of "In Your Best Interest: the Ultimate Guide to the Canadian Bond Market" and a frequent guest on the Business News Network. (You can view his latest June 7 appearance by clicking here.)
