The former head of Pimco’s Canadian portfolio management team is not buying into the view that the Bank of Canada should raise its main policy rate by half a percentage point next month.
“The market is now pricing an actual tightening, even though we’re still emerging from a pandemic, and we’re dealing with, you know, the outbreak of war in Europe. For me, this starts to smell like an overshoot,” said Ed Devlin, the founder and managing partner of Devlin Capital, in an interview Tuesday.
In recent days, numerous calls have emerged for the Bank of Canada to ramp up its rate-hiking program, particularly after Sharon Kozicki, a deputy governor at the central bank, stated on Friday there’s willingness to “act forcefully” to rein in inflation.
Bank of America’s global research team joined the calls for half-point hikes on Tuesday. In a report to clients, its economist for Canada, Carlos Capistran, said he’s now expecting the Bank of Canada to raise its main policy rate by 50 basis points at its meetings in April, June, and July — followed by quarter-point hikes until the target for the overnight rate hits 3.25 per cent in March 2023, compared to its current level of 0.50 per cent.
Capistran pointed to rising inflation, a tighter labor market, higher commodity prices as a result of the invasion of Ukraine, and a more hawkish US Federal Reserve as his main reasons for saying the Bank of Canada needs to move more aggressively.
However, Devlin suggests it would be prudent for the Bank of Canada to not act in haste as Russia’s attack on Ukraine unfolds.
Speaking less than an hour after global equity markets rallied and the price of West Texas Intermediate crude fell below US$100 after encouraging signals from the latest round of cease-fire talks, Devlin said the market is being “whipsawed by geopolitical events.”
“I think you want to take every day’s price action with a bit of a grain of salt … we could roll out of bed tomorrow and there’s been an offensive somewhere in Ukraine, and we’re back to where we started.”
The crux of Devlin’s argument against half-point hikes is that it’s too soon to say whether the surge in inflation is being driven by supply shocks stemming from the pandemic or demand. On top of that, he said central bankers also have to consider commodity supply disruptions caused by the invasion of Ukraine.
In the Bank of Canada’s most recent decision on March 2, when it raised its main policy rate for the first time since 2018, it said the turmoil in Ukraine “is a major new source of uncertainty.” It also cautioned that the stubbornly high consumer price index (CPI) could cause Canadians’ long-term inflation expectations to “drift upwards.” Statistics Canada’s CPI jumped 5.7 per hundred year-over-year in February, marking the largest annualized increase since August 1991.
And while the CPI has been consistently above the Bank of Canada’s one to three per cent target range since last April, Devlin noted that’s a reversal from the pre-pandemic trend.
“Since 2008, we’ve been missing our inflation target to the downside. And, you know, I really worry about, you know, as we start to hike rates — if we take away the punch bowl too quickly, that we end up right back at zero interest rates a few years from now. And you know, I think that’s a pretty bad outcome.”