Chad Moore Calgary Mortgage Broker

What Do You Think Keeps The Bank of Canada Up At Night? Inflation? Or Deflation? Neither …It’s Stagflation!

Let’s Talk About It:

1. Inflationary pressure.
2. Deflationary pressure.
3. Stagflation. What is it.

Inflationary Pressure:

Ask your parents what they remember from an inflationary economy?

Inflation ran wild in the 1980’s, like a pent up puppy released into a dog park. Canada’s central bankers had to spike interest rates to “collar that dog” to bring inflation back under control.

Ever since, inflationary pressure has eased with interest rates trending lower for close to 40 years now. In the 90’s, the primary mandate for the Bank of Canada was created to keep inflation between 1-3%. Low and stable.

Traditional monetary policy response to economic expansion and contraction have been to increase or decrease the key overnight lending rate in Canada. The 2020 health crisis, and resulting economic shock, dropped Canada’s key lending rate to 0.25%.

As this health crisis passes, and our economy returns to some semblance of “normal”, inflaitonary pressures are a threat. Here’s why:

1. Central interest rates rise. If inflationary pressure turns out to be persistent, or more persistent than anticipated, a sharp rise interest rise in response is a threat.
   
2. Bond prices tank. Bond prices and bond yields are inverse to each other. If the Bank of Canada stops their quantitative easing (bond purchase program) bond prices are a threat to tank, driving yields higher that in turn would drive fixed Mortgage rates higher.
   
3. Defaults. Governments, servicing their own debt, is a troublesome issue our policy makers are not planning on confronting. Many of Canada’s home owners have now secured artificially low Mortgage rates, that if normalized, is a threat to our economy.
   
   Many worry that allowing current inflationary pressure to naturally pass through the current economic re-opening is a threat. What if inflation does not subside? Central Banks would be reacting to a lagging economic indicator through rate hikes. A rate increase usually takes 12-18 months to work it’s way through the financial system. Multiple rate hikes in a short period of time would be a big shock to the financial system.

Deflationary Pressure:

Think back to 2019 (ahh the good old days, right?). We had generationally low unemployment, high labour participation rates (people looking for work who were not employed), relatively low interest rates, close to no slack in Canada’s national economy …and we were barely meeting the Bank of Canada’s inflation target. Why? The three D’s.

1. Debt. If I pile up debt on my credit card, I am pulling my future spending forward. This creates a future spending hangover. When I eventually go to pay my debt down, I am not spending on “other things”. Debt pay down is deflationary in nature.
   
   When I spend beyond my means, and do so for a long time, new habits are formed. My way of being and engaging in my life becomes a “new normal”. My way of life becomes “this is the way things will always be”.
   
   Paying down my debt, or simply using my money to service the interest cost of my debt, is deflationary because my dollars are not spent in the economy any longer. Less spending in the economy is deflationary.
   
2. Demographics. I think an aging population is a sign of a prosperous and healthy civilization. However, as populations age, in general, they spend less (new homes, vehicles, vacations, clothing, growing families etc). Aging populations also provide a smaller tax base and draw on social services more.
   
3. Digitization. Look no further than Amazon. For all the people Amazon employs, more robots work for them than humans! Companies look to reduce expenses and increase revenue to appease their shareholders. Human capital is a expense that can be reduced with technology and a digital workplace.

Stagflation:

Google’s definition of stagflation: “persistent high inflation combined with high unemployment and stagnant demand in a country’s economy.”

The Bank of Canada and the U.S. Federal Reserve are becoming more focused on returning the economy to pre-pandemic employment AND maintaining low stable inflation (1-3%).

Raising interest rates and or early quantitative tightening (pulling back on each central banks bond purchase program) is cited as not helpful for employment.

I can imagine how uncomfortable central banks might become if inflationary pressure continues to mount, but employment continues to lag behind pre pandemic numbers.

I think when Tiff Macklem (Governor of the Bank of Canada) and Jerome Powell (Chairman of the U.S. Federal Reserve) go to sleep at night, this is what keeps them up.

Conclusion:

Stagflation might be the “ation” word that keeps central bankers up at night.

For now, Mortgage rates are “safe” with the 10 year U.S. Treasury Yield dropping:

If you are planning to sell, purchase, renew or refinance your Mortgage – be sure to reach out to me to help you. Thank you in advance!

Talk soon,
Chad Moore