Why Interest Rates May Rise Slowly: Tal

Benjamin-TalBenjamin Tal is one of Canada’s most quoted domestic economists. In speaking to an audience at Dominion Lending Centre’s National Conference, Tal outlined why interest rates may take the slow road higher.

Echoing words from the U.S. Federal Reserve, Tal said we’re in an “unusually uncertain market.” Canadian and U.S. central bankers would be the “first to admit” they don’t know what to do.

When policy makers don’t know what to do, says Tal, they tend to be “very conservative.” That is essential because:

  • Trillions of dollars in economic output are riding on interest rate policy
  • Past recessions have frequently been caused by “monetary policy error.”

Complicating things is the fact that we’re in the midst of what could become an oil shock. Every oil shock of the last 40 years has ended in recession, stated Tal. If history is any guide, this raises the odds of economic weakness next year.

Tal summed up by saying that deleveraging consumers, tapped-out government budgets, and a double-dipping U.S. housing market all reinforce the slowdown theory. He indicated there is nothing to suggest that persistent inflation is waiting nearby in the wings.

For these reasons, Tal expects no U.S. economic recovery for at least a year. He says the most important indicator the Fed is watching is the relatively lifeless U.S labour market.

“The Fed is not even dreaming of raising rates in the next 12 months,” Tal told the audience.

As for the Bank of Canada, it has no desire to derail our U.S.-linked recovery in the absence of troublesome core inflation. It will therefore limit Canada’s rate increases, he says, at least until the Fed starts tightening.


Sidebar: For those who expect the June 30 end of quantitative easing (QE) to inflate bond yields (and mortgage rates), Tal says worry not. The market is already pricing it in.

He said the U.S. Fed’s latest round of QE lowered bond yields by just 5-7 basis points.


Robert McLister, CMT

  1. Nothing new there. The U.S. Federal Reserve are clearly navigating uncharted waters. When QE2 ends in June, there is much speculation about how investors would react and whether there will be another round of QE.
    Some people, like Pimco’s Bill Gross, believe that prices would drop and yields would spike once the Fed no longer purchases these long-term bonds. Others believe that the end of QE2 was advertised well in advance. Given that the markets have had some time to prepare for the end of QE2, the transition won’t be so dramatic. Time will tell.
    U.S. interest rates will remain low for a while, probably until early to mid-2012 barring some miracle. The housing sector there is extremely weak and even though unemployment dropped throughout the year, the big picture is quite fragile. As long as inflation remains under control, the BoC should be able to hold the fort on rates. But the high Canadian dollar is wreaking havoc in domestic manufacturers exporting to the U.S. and the only way to offset that is for the U.S. economy to gradually pick up the pace. So far, there are no indications that this is happening. The U.S. economy is basically like a cork floating in the water and this is why the BoC may have to raise rates sooner than the Fed.

  2. My guess is that prime rate won’t go up until October. Things will get worse before they improve. Too much risk out there.

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