MNI INTERVIEW: BOC Primed For Another Jumbo Cut- Ed Devlin

MNI (OTTAWA) - Another jumbo Bank of Canada interest-rate cut is fully justified because a flagging economy means officials need to quickly bring policy to a neutral or stimulative setting according to Ed Devlin, a major bond investor who has presented at central bank policy workshops.

“The quicker the better,” Devlin told MNI's FedSpeak podcast. "We need at a minimum a neutral monetary policy if not possibly an accommodative one." (See: MNI INTERVIEW: BOC Has Room To Keep Cutting By 50BPS: Senator)

BOC Governor Tiff Macklem lowered the overnight benchmark 50bps to 3.75% in October after three earlier 25bp moves, citing confidence inflation will stabilize at his 2% target. Investors are split on whether the Dec. 11 meeting brings a half or a quarter point reduction. Most analysts agree with Devlin that the Bank's rate will drop to around the Bank's estimate of neutral of 2.75% next year.  

Policy remains tight compared even with the last inflation report showing a bump up to 2% on a short-term lift in gasoline prices. Economic growth has also showed signs of stumbling and the jobless rate has climbed by about a percentage point. 

NOT DOING GREAT

Devlin sees deeper weakness and the risk of a hard landing with consumers facing a refinancing shock on mortgage loans first taken out when the Bank's key rate was near zero. “The consumer is not doing great,” he said. “You’re seeing debt moving up in credit cards, you’re looking at delinquencies in auto loans and other things.”

Central bank officials also say the risks to their projection relate to consumers, but those can be two-sided and their baseline view is stable inflation and accelerating growth. Devlin pointed to other cracks such as elevated youth and immigrant unemployment, adding the government's plan to slow population growth and rebalance the job market will take years. “Per capita GDP is recession, and so the only reason we’ve avoided a recession is the millions of immigrants we’ve taken,” Devlin said.

Some of Canada's policy risks are shared across major economies, he said. Central banks holding tight policy for too long will be pressured into another cycle of unhealthy rock-bottom borrowing costs, while loose fiscal policy crowds out investment and later leads to slash-and-burn policies hurting growth. 

“My basic forecast is that the U.S. and the western world will look a lot like Canada did in the early '90s, when remember we were the basket case of the G7, and the interest on the debt became so large that Canadians said enough, and it became politically popular for fiscal consolidation,” said Devlin, a former Pimco fund manager. 

DOLLAR FALLING 5-10 CENTS

Canada's deficit is about 1% of GDP versus 7% in the U.S., but neither country has spelled out how to return to balance. “You can sit and talk about the deficit being smaller up here, but our debt to GDP spiked more than I think virtually any other G7 country during the pandemic,” he said. IMF figures show Canada's general government debt grew larger than the economy during the pandemic, to 107% of GDP in 2022 from 90% in 2019. (See: MNI INTERVIEW: Trudeau Deficit Cap Strained By Election Threat)

For now, much lower Canadian bond yields have Devlin moving money into U.S. debt, the kind of trade that has pushed Canada's dollar to the weakest in several years. BOC officials have said the gap on official rates is nowhere near its limit. The difference between the BOC rate and the bottom of the Fed's target band is 75bps and was 100bps earlier this year, compared to a gap of 250bps in the 1990s. Still, some investors say a weak dollar may slow down BOC rate cuts, a view Devlin rejects.

“An orderly depreciation of the currency that reflects the economic fundamentals actually does the work for the Bank in many ways,” he said. “A depreciating currency means we get to import some growth that we’re not able to generate ourselves.”

“I don’t think a big tumble is in the works, but I think a depreciation of another five cents, or possibility even 10 I would say, but I think five cents is very likely,” Devlin said.