How terrible "professional" forecasters are at predicting Canadian bond yields and interest rates
June 22, 2019
Erik Fertsman
Yesterday, BNN Bloomberg posted a Q&A article
that asked a number of professionals what the Bank of Canada would do if the US's Federal Reserve cut interest rates. Would it follow, or does the Bank have some flexibility?
According to Ed Devlin, head of a Canadian portfolio management firm, Canadian inflation and macroeconomic data is more positive than what the US is facing, and so the Bank of Canada doesn't need to cut rates. Similarly, CIBC's Chief Economist, Ben Tal responded by saying the Bank could leave rates untouched for up to a year considering the economic cycle in Canada has been muted, and Canadian rates are lower than US rates. Even Sherry Cooper, Chief Economist at Dominion Lending Centers believes rate cuts are not necessary for the Canadian central bank, considering the lowest unemployment rate in history, good consumer spending, and rising inflation in Canada. Cooper even thinks that a no-rate-cut by the Bank is already priced into the Canadian dollar.
Meanwhile, TD's senior economist also believes the Bank of Canada can chill: the Fed is cutting for insurance purposes, and to, you know, reduce the risks, but Canada's economy is "healthy." RBC's Josh Nye had a more sophisticated answer: if the Fed was cutting for insurance purposes, then the Bank would hold off, but if the Fed was cutting because of actual economic growth deterioration, then the Bank of Canada would follow. BMO's chief economist and managing director followed his big six bank peers and their answers.
In contrast, Rosenberg, who I've picked apart recently, thinks Canada is a "price-taker" that would cut rates in lockstep with the Fed. Even if the Bank doesn't cut the same day, the Canadian economist has no doubts that Poloz will follow, especially given the bullish pressure a Fed rate-cut would put on the Canadian dollar.
How forecasters failed at predicting the US Fed rate
It was virtually certain that the Fed would lower rates. Then came the day... but the Fed didn't cut rates...
#Fed keeps its rate neutral at today's announcement. This is what I expected considering the #economic data, especially #nGDP. The Fed needs to quickly realize that rate targeting won't help it alter long term growth trajectory. #Banking #reform will. https://t.co/jq5aglpcf7
— Erik Fertsman (@ErikFertsman) June 19, 2019
Chief Economist at beleaguered Deutsche Bank, Torsten Slok, came up with a handy chart to show just how terrible markets have been at anticipating or predicting interest rates at the Federal Reserve. pic.twitter.com/mWRbPIYk1L
— Erik Fertsman (@ErikFertsman) June 13, 2019
Just how bad are forecasters at predicting Canadian rates?
Back in January of this year, Bank of Canada staff shared this chart in a note devoted specifically to interest rate forecasting. What they found was that, well, since about the early 2000s forecasters have been expecting interest rates to rise, but they haven't! Turns out, Canadians are no better at forecasting interest rates than US forecasters (hehe).
As you can see, between 2001 and now, interest rates have really
not gone the way models have anticipated. This is a big problem for the Bank of Canada because it could impact participation in the Canadian bond market. If yields are unpredictable, then it makes things a bit more risky. That being said, the note did
mention how bond profits were still considerable when compared with the stock market within the same period. This makes sense, considering bond prices go up when bond yields go down. Yet, if forecasters are constantly... sorry, but for decades (!), saying "get your mortgage now, get your home refinanced now, before interest rates go up" but rates just keep diving lower, isn't that not
benefiting home owners who end up getting locked into higher rates?
Plus, if you're someone who has followed mortgage rules in Canada, then you probably know that rising interest rate expectations are one of the primary reasons underpinning the stress-test rules that have contributed to the collapse in high-ratio mortgages underwritten by the big six banks and other small lenders. This collapse in mortgage origination has led to price decreases in housing markets across Canada, especially in the more expensive markets like Toronto and Vancouver.
What is to be done about these pesky forecasts?
Well, for starters it's probably worth understanding that interest rates follow nominal GDP growth, or at least it's good record - and logic - suggests that they should. So, if nGDP is forecasted to be lower, then rates should be as well. There is a tiny problem here though, like the fact that GDP forecasting also has a terrible record. Let's just try to remember that nGDP = interest rates, ok?
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