PrefBlog

The ongoing slide in the TXPR index is perplexing; surely with inflation becoming more of a menace, the five-year bond yield (GOC-5) must be on the way up! This shouldn’t make much, if any, difference to FixedReset prices of course, since what is important is spreads, not the absolute value of the expected dividends that should be critical – but the absolute value has been important in the past!

The GOC-5 has been gyrating recently between fear of inflation and a rush to quality, but overall the effect has been minor; the TXPR price index is down about 3.5% year-to-date and is now about even with its value on April 27, 2021 (when GOC-5 was about 0.87%, compared to 1.60% today). Robert McLister has an interesting piece in the Globe:

Of all the things that could possibly move Canadian mortgage rates, a murderous dictator committed to nuclear brinkmanship was not on the radar.
…
After the Russian President put his nuclear forces on high alert, BCA ballparked chances of a “civilization-ending global nuclear war” at 10 per cent in the next 12 months. Its surreal commentary would be hyperbolic if only we were dealing with a more stable adversary.

Whatever the true doomsday probability, the mere notion of nuclear weaponry being used in an escalation of the Russian war on Ukraine, and more broadly a recession that may result from soaring commodity-stoked inflation, has driven investors into the safe harbour of government bonds.

That bond buying crushed Canada’s five-year yield by more than 30 basis points in just days. By Tuesday evening, the yield had bounced back somewhat, trading at 1.61 per cent – down from a Feb. 16 high of 1.859 per cent. (There are 100 basis points in a percentage point.)
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These previously unthinkable scenarios have spawned two trends.

The first is a surge in risk premiums. That is, market fear and uncertainty are raising the cost of mortgage funding relative to risk-free government bonds. So despite bond yields dropping, banks have been hesitant to cut fixed mortgage rates, especially with competition already squeezing profit margins.

Second, there’s a very real danger that central banks temporarily lose control of inflation. Textbooks say this risk should be met by aggressive short-term rate tightening. And if it is, variable mortgage rates will go along for the ride.
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Mr. Volcker was a Federal Reserve chair who had to use brute-force rate hikes to battle inflation expectations, driving North America into painful recessions in the early 1980s. Central banks should have learned a lesson from Mr. Volcker’s predecessors – that worrying too much about killing the economy short-term can lead to dire inflation that ravages the economy long-term.

The next 30 days of war could rewrite the inflation and growth narrative again. For all anyone knows, the probability of recession next year could skyrocket, with rates tumbling back down.

Whatever! Prices are down but spreads are up, allowing increased purchasing with reinvested dividends to mitigate the disappointment of holding an asset with decreased prices. Market price is a mere bagatelle, of interest only to market timers (who will eventually lose all their money anyway) and those with a definite need to dip into capital in the short- to medium-term (who should have funds dedicated to this purpose invested in something else). Those of us who may consider ourselves rational long-term investors should, on balance, be pleased with the volatility in the preferred share market – it keeps the dilettantes and their money away from the market and so serves to increase our liquidity premium – discussed here on many occasions, for instance here.

This entry was posted on Tuesday, March 8th, 2022 at 9:59 pm and is filed under Market Action. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.