A Taper Without a Tantrum

Yesterday the Bank of Canada became the first of the major central banks to reel in purchases of government bonds by announcing weekly purchases would shrink by 25% down to C$3bn. It also unsurprisingly upped its 2021 GDP forecast to 6.5% from 4%. However, the most interesting development from our point of view was that the Bank of Canada now expects the economy to hit its inflation targets as early as the second half of 2022.

Canadian government bond yields moved marginally higher from 1.50% to 1.52% at the 10-year point following this hawkish announcement. Had this happened a month ago, we suspect the move would be materially more pronounced, and the muted reaction indicates to us that markets are now quite comfortable with the current levels of expected growth, forecast inflation, and yields.

The read-across for the more globally scrutinised US Treasury market could be quite interesting. During Q1, Fed officials sought to distance themselves as much as possible from hawkish comments, and there was no hint at even the possibility of tapering purchases any time soon. The Fed’s reluctance to embrace a hawkish stance makes complete sense, as that would have thrown petrol onto a blazing fire. Still, I’m sure Fed officials have observed the calmness in the Canadian market and may glean some confidence that tapering would not result in an unwelcome tightening of financial conditions after all, which makes this topic marginally more likely to be discussed sooner.

Eventual tapering by the Fed was certainly on our list of potential catalysts to begin a second wave of US Treasury selling. While we don’t rule that out for the future, it is encouraging to see relative calmness in the world’s biggest bond market as Canadian policymakers begin to taper.