It’s Probably a Duck

Steve Saretsky -

At the onset of the pandemic, Bank of Canada Governor Tiff Macklem pounded the table, urging Canadians to borrow money to prevent us from sliding into an economic depression. “Our message to Canadians is that interest rates are very low and they’re going to be there for a long time. If you’ve got a mortgage or if you’re considering making a major purchase, or you’re a business and you’re considering making an investment, you can be confident rates will be low for a long time.”

Sure enough, Macklem has made good on his promise, soaking up supply in the bond market, and driving bond yields (borrowing costs) lower. As of today, The Bank of Canada now owns 40% of the entire Government of Canada bond market. Since Q2, 2019, the central bank has absorbed and essentially funded 92% of the Canadian Governments budget deficit.

Again this begs the question, are we in the early days of adopting Modern Monetary Theory? If you’re unfamiliar with the term, it’s essentially the new buzz word and a growing idea for reimagining monetary and fiscal policy. The central idea is that governments with a fiat currency system under their control can and should print (or create with a few keystrokes in today’s digital age) as much money as they need to spend because they cannot go broke or be insolvent unless a political decision to do so is taken.

So, are we adopting MMT? Well, If it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck.

The jury is still out on how this will all play out, but clearly the central banks increasing role in the bond market and the overwhelming new money supply being created by the federal government is creating an environment supportive of rising asset prices (think housing).

In a desperate attempt to counter-act these policies, OSFI, the banking regulator, is adhering to the growing demands to curb mortgage credit growth, and slow the pace of house price appreciation. OSFI has announced plans to increase the mortgage stress test, proposing a new qualifying rate for uninsured mortgages. The higher of the mortgage contract rate plus 2% or 5.25% as a minimum floor. In other words, the qualifying rate will move higher from 4.79% to 5.25%. This will reduce borrowing power by about 4.5%. Realistically this will do little, at best it might slow the pace of house price inflation, but it does highlight that policy makers are indeed watching with a close eye.

Following the move, Finance minister Chrystia Freeland chimed in, “We will continue to monitor housing market conditions across the country. To inform potential steps the government may take, we will closely examine the results of the consultation announced by the Superintendent of Financial Institutions.”

Sounds like nothing imminent from the Federal Government, despite a looming budget announcement coming soon. Either way, the Bank of Canada will be busy at the bond auctions. Giddy up!

Three Things I’m Watching:

1. The Bank of Canada has recently funded 92% of the Canadian Government’s budget deficit. Modern Monetary Theory? (Source: Richard Dias)

2. Rapidly inflating house prices has prompted OSFI to beef up the stress test for uninsured mortgages. (source: Bloomberg)

3. The revamped stress test will reduce borrowing power by 4.5%. Albeit, much less than when the existing stress test was first announced a couple years ago. (National Bank of Canada)

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The Saretsky Report. December 2022