‘Flashing warning signs’: Canadian markets bracing for ‘dramatic’ Bank of Canada action — and a recession

OTTAWA ? Recent moves in Canadian markets claim that investors see increased likelihood of an economic downturn this season and the possibility of “dramatic action” from the Bank of Canada.

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An ominous signal continues to be appearing previously month as corporate bonds and government of Canada bonds have experienced their spreads widen, a move that always precedes a recession. Meanwhile, yields on the five-year Government of Canada bond have started creeping underneath the central bank’s overnight lending rate of 0.5 percent. , they traded at roughly five basis points below that mark.

Canadian stocks are another area of weakness, with the S&P/TSX Composite Index once again slumping into a bear market . The TSX closed down 2.02 per cent, or 252.75 points, to 12,282.65, now down a lot more than 20 per cent since the highs of September 2014.

“Looking at the signals from the financial world there are a number of recession indicators that are flashing indicators,” said Mark Chandler, head of Canadian fixed-income strategy at RBC Dominion Securities.

This is real, there is something happening here

The last time short-term bond rates inverted this far out across the curve was at the very first 1 / 2 of 2015, which wound up turning into a technical recession – defined as two back-to-back quarters of economic contraction.

In an ordinary bond market, longer-dated bonds have higher yields as investors require more compensation to lend money for an extended period of time. When multi-year bonds move underneath the overnight rate – the eye rate the financial institution of Canada charges banks to lend to each other for any day – this means investors are expecting the overnight rate to visit lower in response to a weakening economy.

Corporate spreads have also been widening in Canada for much of the final 12 months, as well as the most part that was because of an increasing number of distressed energy companies. Chandler states that the widening has now spread to non-energy companies as well.

“This is real. There is something happening here,” he explained. “Usually one of the most powerful indicators is widening of credit spreads, and that is happening not just in the energy sector, but additionally more broadly.”

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Canadian banks, one of the most exposed companies towards the domestic economy, have grown to be one of the big drags around the TSX Composite Index. On Tuesday, the biggest banks, including the Royal Bank of Canada, Toronto-Dominion Bank and Bank of Nova Scotia, saw their shares dip more than two per cent.

Craig Basinger, chief investment officer at Richardson GMP Limited, notes that some Canadian stocks are now trading at “recession-type” valuations. The banks, for example, trade in the only digits or close to it, with dividend yields creeping in to the 4 and 5 percent range.

Basinger said the pricing suggests investors are seeing more pain on the horizon.

“Yes, we’re able to certainly visit a bit of a recession here and yes, oil costs are below $30 a barrel again, but valuations have grown to be compelling,” he added. “If we enter a recession, well, the prices already are there.”



The indicators in financial markets come as the Bank of Canada left its overnight lending rate unchanged during its policy announcement recently. Governor Stephen Poloz asserted he was waiting to determine the size of stimulus in the federal government prior to making moving. The budget, which will outline stimulus details, is expected to land between March or April.

The Bank of Canada also noted there are early indications the non-energy segment from the economy is rebounding as low oil prices along with a weak loonie make exports more competitive. Non-energy exports helped close the trade deficit down to $585 million in December, an unexpected to economists who had expected the trade deficit to develop from $1.6 billion in November to $2.2 billion.

As well, January’s employment report demonstrated that, while oil-dependent provinces such as Alberta, Saskatchewan and Newfoundland and Labrador still bleed jobs, non-energy provinces are booming. Ontario has added 100,000 new jobs previously 12 months, while British Columbia and Quebec have also posted healthy job gains.

“Growth remains positive away from oil-rich provinces, supported by an upturn in exports and steadier consumer spending and home sales,” said Sal Guatieri, senior economist at BMO Capital Markets within the bank’s latest economic outlook released Feb. 5.

Still, Guatieri expects the Bank of Canada will a minimum of move to cut its benchmark rate by 25 basis points to its post-recession low of 0.25 % between the spring.

Chandler of RBC said that investors should seriously consider the bond market in the coming weeks. If short rates move off current lows, then it’s likely the Bank of Canada will be less dovish. But a long period of inverted yields could signal more drastic action.

“I think with your short-term rates – where we’ve five-year yields now below 50 basis points – to be able to justify those for any prolonged period of time, the market is certainly pricing in high chance of some pretty dramatic action by the central bank,” he said. “Whether it’s negative rates of interest or potential for QE, it’s hard to justify the current yields without those expectations.”

jshmuel@nationalpost.com

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