Shortly after 2 p.m. one day in September, in a men's locker room at a Bay Street gym, the half-dozen patrons in one aisle all stop towelling themselves off and stare at the TV. Are they glued to a sports channel showing highlights from last night's baseball games? A Beyoncé video? No, it's all about bonds. Some nebbishes on CNBC are jabbering excitedly about an announcement released minutes earlier by the U.S. Federal Reserve's Open Market Committee-a decision to keep its benchmark federal funds rate near historic lows of between 0% and 0.25%.
And that means bond action, baby, big time. Monthly releases of key economic statistics by government agencies, and interest rate decisions by central banks, are the lifeblood of the bond market. Those numbers give traders around the world clues about where economies and interest rates are headed. It's why they obsess about things like the "nonfarm payrolls"-the total of jobs gained or lost in nonfarm sectors of the U.S. economy, which is in the employment report released every month by the U.S. Labor Department.
Right now the stakes are higher than ever, because bonds appear to be in a bubble. After the worldwide stock market crash of 2008, investors began stampeding into bonds.
Bond prices and yields are inversely related-if investors bid up the price of a two-year bond with a 5% interest coupon from its face value of $100 to $104, its yield to maturity drops below 3% a year, because interest is paid on the face value. Bond markets are so frothy that two-year Government of Canada (GofC) bonds now yield less than 1.5%, and two-year U.S. Treasury bonds yield less than 0.5%. The mid-1950s was the last time the yields on U.S. government bonds were as low as they have been of late. Yields on corporate bonds-which are riskier than government issues-are only slightly higher.
How long will the bubble last? Jim Byrd, a managing director of RBC Capital Markets who's in charge of its team of GofC bond traders and analysts, says it could go on for quite a while, mostly because the U.S. Federal Reserve is buying huge amounts of bonds and keeping interest rates near zero. But the team can't settle in and relax for the long haul. They have to respond to shifts in prices and yields minute-by-minute.
To see how it all works, Report on Business magazine visited RBC's bond and currency traders on the morning of Oct. 19, the day of an interest rate announcement by the Bank of Canada. Here are scenes from a market near its peak.
THE PREGAME RBC's traders and analysts arrive at work each day before 7 a.m. The Bank of Canada issues rate announcements eight times a year. On those days, Mark Chandler, RBC's head of research for Canadian bonds and currency, provides instant analysis of the Bank's decision when it's released at 9. A few minutes before then on Oct. 19, he looks completely relaxed. "These guys are the rock stars," he says of the traders. "I'm just the roadie." Chandler says the traders will want him to write a report and send it to RBC's major bond clients-large pension funds, mutual funds and the like-within "about three seconds" of the announcement. "But I like to think about it for a few minutes."
Besides, like almost every other analyst and trader on Bay Street, Chandler has already predicted that the Bank will keep its benchmark overnight rate at 1% today. Analysts and traders pretty much have to call rate decisions correctly days or even weeks in advance. RBC traders say that the last time the Bank really surprised the market was August, 1998, when an unscheduled announcement jacked up rates by a percentage point amidst a global currency crisis. Frank Salmonds, an RBC managing director, quips that if the Bank raises rates this morning, "you'd find our bodies under our desks."
Everyone also knows the policy dilemmas that Bank of Canada Governor Mark Carney is facing. Like the U.S. Federal Reserve, the Bank of Canada slashed its benchmark rates to practically zero in late 2008 and early 2009 to try to help ward off a depression. But Washington and Ottawa also started running huge budget deficits, and the combination of low rates and big deficits often leads to inflation. Last spring, Carney began talking about the need to ease rates back up to contain inflationary pressures. And from June to September, he hiked the Bank's overnight rate from 0.25% to 1%.
But investors have continued to push GofC bond prices up and yields lower, figuring that economic recoveries in both the United States and Canada are sputtering, and deflation is more of a danger than inflation. Does Carney want to risk choking off a recovery with another rate hike?
PARSING CARNEY Central bankers like the Bank of Canada's Mark Carney speak their own convoluted language in official statements, because they don't want to create panic-or euphoria-in financial markets. The governor's deliberately arcane wording has to be decoded by analysts at banks and investment dealers.