Quantitative easing: Gargantuan central banks monetizing fiscal stimulus

I was reading in the paper today that Congress wants to replace the dollar bill with a coin. They’ve already done it. It’s called a nickel.

Jay Leno

Monetary and fiscal policy are on a mission to rescue the economy and confidence, but it’s coming at a steep cost. With debt issuance by Canada’s Federal government and all 10 provinces rising fast, the Bank of Canada (BoC) has been aggressively expanding its balance sheet to avoid a disorderly outcome for the bond market by largely absorbing debt issuance. The BoC has added about $320BN to its balance sheet in recent weeks while the U.S. Federal Reserve added $2.9TN. Last week, we learned that the Federal government’s deficit would reach $260BN based on measures announced as of April 30th (Source: Global News)[1]. We would not be surprised to see the deficit blow past the $300BN mark, which would represent roughly $8,000 per capita.

Chart 1: Central-Bank Balance Sheets Surging, (Lots) More to Come

Chart 1: Central-Bank Balance Sheets Surging, (Lots) More to Come

Source: Bloomberg, BMO GAM (May 27, 2020)

Loonie: Flying high, but pulled by global risk sentiment

The loonie is modestly higher so far this month, but we still prefer to leave the bulk of our foreign exchange exposures unhedged to currency movements in our portfolios. While we are upbeat about stocks, our stance remains cautious and we continue to see our U.S. assets acting as a volatility dampener if investor sentiment gets tested again by a bout of COVID worries, in which case would we would expect to see the loonie retreat.

Portfolio Update #1: Increasing U.S. stocks, reducing Canada

Last week added to our U.S. equity overweight while reducing further our exposures to our core Canadian stocks in our ETF portfolios. While near-term prospects for global equities look attractive, we think Canada could lag the U.S. over the medium term. As COVID becomes increasingly contained and less feared, we think fundamentals will eventually drive asset prices more sensibly. Over the next 12 to 18 months, we think Canada’s economy and stock market are in a weaker position compared to other major economies, particularly the U.S.

First, Canadian equities were underperforming well before COVID and oil sector woes hit. After a brief period of outperformance in mid-2019 as the trade war raged on, Canadian equities lost its vigour and underperformed most other regions in the 4th quarter of 2019. Hopes over a global growth inflection intensified during this time whereas the domestic economy looked increasingly on weak footing due to softening business Capex, exports and consumer spending. As the global economy recovers from the virus-induced unemployment shock, Canadian consumers are most vulnerable thanks to record low savings rates, historically high debt-to-income and debt service ratios. This means that the economic recovery in Canada will be slower which will weigh on earnings growth as about 40% of revenues are driven domestically, versus over 55% for S&P 500 companies. We continue to prefer an underweight to Canadian equities vs U.S. and EM Asia although Canadian stocks have held up nicely since April (Chart 2).

Chart 2: U.S. Stocks Leading, Canadian Stocks Surprisingly not too Far Behind

Chart 2: U.S. Stocks Leading, Canadian Stocks Surprisingly not too Far Behind

Source: Bloomberg, BMO GAM (May 27, 2020)

Portfolio Update #2

We also added an active high-yield (HY) fixed-income manager in our Select Class family of portfolios, which we funded by reducing our beta-one HY exposures. While central banks are actively buying corporate bonds and risk sentiment is stabilizing, we believe the wave of bankruptcies is an ideal market environment for active managers to add value within the HY space.

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