MNI INTERVIEW: BOC Is Sounding Like Volcker- Ex-Volcker Aide

Investors are underestimating Bank of Canada Governor Tiff Macklem's resolve to tackle stubborn inflation the way Paul Volcker did, and to keep up with current Fed Chair Jerome Powell's tightening, former Volcker aide Sherry Cooper told MNI.

Macklem will raise interest rates more than investors predict towards 5% and hold until it's clear that core inflation is coming back under control, according to Cooper. The Fed will take a similar path, said Cooper, who has also worked at Fannie Mae and is chief economist at Dominion Lending Centres, a Canadian mortgage and leasing company.

“Tiff Macklem, what he’s saying is very reminiscent of what Volcker said, and same thing with Jay Powell, because they are both from the same mindset, which is the number one job of the central bank is to ensure price stability,” she said. “I’m heartened by the fact that both of the central bank chiefs are doing what I think is the right thing to break the back of inflation.”

Canadian investors are off base in predicting today's 3.25% policy rate will peak around 4% in the next few months and be cut next year, Cooper said. Central banks are playing catch-up after keeping rates low as the pandemic eased and then saying tightening to low neutral rates could be sufficient, though that was understandable given confusing Covid lockdowns, she said.

RAISING DRAMATICALLY ISN'T ENOUGH

“They have raised rates dramatically, but that doesn’t mean they’ve raised them enough yet,” she said. “Until you can approach at least zero real interest rates, you’re not really addressing the real underlying inflation.” Canada's latest CPI reading is 7%.

“The policy rate will settle around between 4 and 5%, and probably closer to 5, especially in the U.S.,” Cooper said. While Canadian government two-year bond yields reached the highest since 2007 after Macklem's recent speech saying it's too soon to talk about a measured approach, at 4.1% they're in line with the economist consensus for a terminal rate of just 4%.

Canada's dollar has also wilted 11% under the strength of the U.S. dollar's safe haven status over the last year, and on bets the Fed will hike more. That depreciation counters a recent history of CAD strength when prices for exported commodity prices rise as they have since the Ukraine war created energy and food shortages. Macklem has been unusually blunt saying the rise in Canada's import prices as the currency declines means he must hike even more.

Borrowing costs don't need to soar into double digits like in the 1970s, Cooper said, but they must stay elevated for a while to rebalance the economy. Today's relative jump from near zero rates is arguably a bigger rout to the bond market and painful for people who have never seen interest costs chew up a mortgage payment, she said.

NOT SEEING EYE-TO-EYE

Some investors “are talking about rates coming down next year, well that’s not going to happen because it takes much longer than that to really do the job," Cooper said. "The Fed and the Bank of Canada aren’t going to cut rates just because the economy slows, they want the economy to slow.”

Cooper, also formerly chief economist at BMO, says housing gains have been "completely unsustainable" and doubts new supply will ease affordability worries. (See: MNI: Trudeau Told Falling Prices To Hurt Homebuilding-Briefing)

Some builders are postponing or cancelling condo projects as buyers hesitate and because commercial lending costs are high, she said. Like everyone else, builders are also struggling with cost inflation. “They probably can’t make money," she said. "The cost of labor and the cost of everything that goes into construction has risen so rapidly.”

Cooper also recalled Volcker's dedication to public service even amid protesters burning him in effigy. “He had sacrificed a much better lifestyle that he could have had, had he been in the private sector,” she said.

Volcker was already something of an icon even before he broke the back of U.S. inflation, wearing sometimes-shabby looking suits and smoking skinny cigars. “He was six-foot-seven-inches all, and I’m five-foot-two, so we had sit down to talk to each other," she said. "It was so strange, I came up to his belt buckle.”