March 7, 2022 | Volcker Moment?

Brace yourselves, we have liftoff! The Bank of Canada officially raised interest rates a mere 25bps last week. This was the first move since 2018 and comes at a time when inflation is running at 30 year highs. Markets believe another 5-7 rate hikes are still coming this year and some are calling this the Paul Volcker moment.

In case you forgot, Paul Volcker was the head of the US Federal Reserve in the 1980’s, the last time inflation was running this high. Volcker raised rates from 11% to 21% in order to squash inflation which undoubtedly caused a lot of pain. Things got so bad that home builders started mailing 2×4 lumber in the mail to Volcker as part of a protest, claiming their lumber was no longer needed since nobody was buying houses.

So is this our Volcker moment?

I think some much needed context is in order. Back in the 1980’s, Canada’s household debt to GDP sat at roughly 40%. Today it is over 100% of GDP. In other words, it’s not going to take much to severely tighten financial conditions. Per David Doyle at Macquarie Macro Research, when you account for private sector debt levels in Canada, assuming we get a total of 6 rate hikes this year (25bps each time), this will equate to the largest tightening cycle since the 1980’s. In other words, our Paul Volcker moment will be bringing rates from zero to 1.5%. Let that sink in.

These are rather precarious times. Not only are we are saddled with debt but we have inflation running at 30 year highs. The central bank is going to try and tame inflation by raising debt servicing payments at a time when commodity prices are poised to surge even higher. Rising fuel prices, food prices and debt payments is not bullish for the Canadian consumer. This is going to be a painful squeeze and households will be forced to pare back spending. This will ultimately feed through into housing, we already seeing activity begin to cool in parts of the country.

Per Hedgeye Research, there have been 12 recessions since 1946. 8 have followed major oil price shocks, while a further 3 have occurred immediately following more modest, but still notable, oil price run-ups.

In other words, it isn’t going to take much for the Bank of Canada to tip the scales, markets are already doing much of the tightening.

Three Things I’m Watching:

1. Accounting for Private sector debt levels, 6 rate hikes will be the most severe tightening since the 1980’s. (Source: Macquarie Research)

2. Wheat prices are surging as future supply appears bleak. Russia and Ukraine supply almost a third of the world’s wheat exports. (Source: Bloomberg)

3. Western Canadian Select oil now running north of $100 / barrel. (Source: Globe & Mail)

Steve Saretsky March 7th, 2022

Posted In: Steve Saretsky Blog

Next: Who Are the Oligarchs? »