5 Responses to “November 21, 2014”

1. prefQC says:

   November 22, 2014 at 5:19 pm

   Hi James,
   Does the BoC have direct control of the 90-day treasury rate like it does (I presume) with the prime rate?

   What is the best way to play the scenario where the bank raises interest rates in mid to late 2015? Would it be via
   (a) one of the many floaters having a dividend directly proportional to prime; or
   (b) a low-spread issue (e.g. conversion of TRP.PR.B @128bps to its floater version in June, although any other low-spread issue may do), for which any increase in the 90-day rate would have the biggest relative effect on the dividend increase?

   Is there a rule of thumb (in this low-interest environment) for the ratio of the 90-day BoC rate increase resulting from an increase of the prime rate (or vice versa)? (e.g. an increase of the prime by a factor of 1.3 corresponding to an increase of the 90-day by 1.5…)

2. jiHymas says:

   November 22, 2014 at 5:54 pm

   As a general rule, you can say that the Bank of Canada has control over exactly one interest rate: the Bank Rate:

   The Bank Rate is the rate of interest that the Bank of
   Canada charges on one-day loans to major financial institutions.

   Everything else flows from there and the question of exactly how it flows is a matter for continual academic inquiry. The bank makes available a number of backgrounders on monetary policy.

   Prime is set by the banks themselves, and is supposed to be the rate at which they will lend to their best and most rock-solid customers, although this definition is suffering from the attentions of the marketing boys (‘Mortgages below prime!’) and is even less meaningful in the States. However, Prime is still a benchmark and used to determine the interest the bank charges on lots of call loans, such as HELOCs, etc.

   Changes in the Bank Rate will normally be transmitted 1:1 to Prime, as you can see from the series of posts on Canada Prime, but this will not necessarily always be the case – for instance a 75bp cut in the Bank Rate led to a cut of only 50bp in Prime in December 2008.

   You will have noted that I said the Bank controls only the Bank Rate ‘as a general rule’. Everything else is a market rate, but there is little – other than market wariness – to prevent the Bank from entering the market and distorting it to meet its policy ends. Quantitative Easing is the most obvious example.

   What is the best way to play the scenario where the bank raises interest rates in mid to late 2015?

   It depends! How much of the rise is already priced in to which securities? What else is going on? I’m afraid there are no easy answers. You may be interested in two of my publications, Some Preferreds To Float Your Boat and Are Floating Prefs Money Market Vehicles?.

   Is there a rule of thumb …

   As alluded to above, you may reasonably assume that changes in the Bank Rate will be transmitted 1:1 to changes in the 90-day Treasury Bill Yield, and transmitted 1:1 to changes in Prime, although there will be some slippage if the historical relationships that were in effect prior to the Credit Crunch re-establish themselves.

3. malcolmm says:

   November 22, 2014 at 6:30 pm

   So the official inflation rate is well over 2%. I wonder what the real inflation rate is.

   I was just reading an article in Macleans about shrinking packaged food sizes. I wonder if Stats Can takes the package size into account when calculating inflation. They have so many tricks to lower the reported rate of inflation.

   Substitution, where if an item like, say, a certain type of apple gets to be too expensive they substitute a cheaper type.

   They also factor in the improved quality of products. For example, computers get faster every year, so even if the price of a “standard” computer doesn’t drop in dollar terms they will calculate that it did because you get more processing speed for your dollar. Of course this doesn’t account for the fact that computer programs and web pages get more complex every year and required more processing power.

   Not to mention the core inflation versus overall inflation nonsense. It seems whichever is lower is the one that gets the headlines, so that people can fret over the looming risk of deflation.

4. jiHymas says:

   November 22, 2014 at 8:24 pm

   I wonder if Stats Can takes the package size into account when calculating inflation.

   Transcript – An Overview of Canada’s Consumer Price Index (CPI):

   For example, if the size of a juice box becomes smaller but the price does not change, consumers are implicitly paying more for the item.

   Quantifying the effect of quality changes is difficult; see, for example, Measurement Bias in the Canadian Consumer Price Index and Measurement Bias in the Canadian
   Consumer Price Index: An Update, as well as discussion at Finiki – Inflation.

   There are plenty of apocalyptic critics of inflation measurement – see, for example, No. 515—PUBLIC COMMENT ON INFLATION MEASUREMENT AND THE CHAINED-CPI (C-CPI) from ShadowStats, which is the most credible critic I know of – with the caveat that I can’t be bothered to look into the matter particularly deeply.

   Look at the two charts about 2/3 of the way down the page, titled “Consumer Inflation – Official vs. ShadowStats (XXXX-based) Alternate” where XXXX is either 1980 or 1990. The “1980” based chart claims that actual inflation has been a little under 10% annually since 2000 or, in other words, that prices have more or less quadrupled over the past 14 years. This is horse-shit. The 1990-based alternate claims an average of somewhere around 5-6% since 2000, thus claiming that prices have at least doubled in the last 14 years. This is also horseshit, merely somewhat less fragrant.

   Then, if we look at Chart 13 in Review of Economic, Systemic-Solvency, Inflation, U.S. Dollar and Gold Circumstances [2012] we see that the numbers imply that “Real Average Weekly Earnings” for “Production and Non-Supervisory Workers” have declined from about $265 [1982-1984 constant dollars] in 1989-95 to about $185 in 2012; which is to say that the real standard of living for these workers has dropped by about 30% over the twenty-odd years. Horseshit, horseshit, horseshit.

   I certainly won’t even attempt to defend every decimal place in the official estimates of inflation – but I will say that I haven’t seen any credible numbers that show much of a difference.

   Not to mention the core inflation versus overall inflation nonsense.

   I don’t consider it to be nonsense at all, and if you look at historical numbers, you’ll see that over the long run they’re pretty much the same, with core numbers being much smoother.

   The danger with core vs. overall inflation is that the definition of “core” is subject to change – it is my understanding that during the 1970’s, one contributor to the Great Inflation was the changing definition of “core” … a relatively highly politicized Federal Reserve kept narrowing the definition to eliminate those segments of the economy over which they had lost control. There’s a reasonably detailed essay titled The Great Inflation – 1965 to 1982 by Michael Bryan of the Federal Reserve Bank of Atlanta in which you may be interested; there’s also a great quote in this article about core inflation:

   Returning to core inflation, the indexes that exclude food and energy were born in the 1970s during the heyday of the Organization of Petroleum Exporting Countries as oil prices rose from $3.50 to $10 a barrel in 1974 and then to $40 in 1980. I saw the impact on inflation measurement close up. As a young economist on the staff of the White House Council of Economic Advisers in 1980, I saw US consumer price inflation hit its modern peak of nearly 20 per cent. In an attempt to improve appearances, we started computing various alternative measures of inflation. Half jokingly, one of my colleagues noted that our job was to remove all the components of the price index that rose by more than the average. What was left was the core.

   However, I don’t see that happening today.

5. jiHymas says:

   November 22, 2014 at 8:34 pm

   I couldn’t resist looking into the books for the figures from when I was setting up the firm in 2000.

   I paid $2,200 for a desktop machine that could run HIMIPref™ and $6,500 for a laptop with equivalent power. Nowadays I buy low-end lap-tops and pay for them out of petty cash – they come in at less than $500.

   I paid a bit more than $800 for a laser printer and my back-up system consisted of a zip drive and 12 disks, which had an incredible capacity of a full 250MB (wow!) cost a bit more than $600.

   And it cost me thirty bucks to execute a trade with a discount broker.