Poloz Says Markets Showing ‘Welcome Symptoms’ of Normalization

(Bloomberg) -- Recent developments in global financial markets -- particularly rising long-term bond yields and volatile stock markets -- are a reflection of strong global economic fundamentals, not weak ones, according to Bank of Canada Governor Stephen Poloz.

In a speech on how to read recent signals from financial markets, Poloz played down recent movements -- such as a flattening yield curve -- as evidence of deterioration. Instead, the focus should be on a recent increase in yields signaling the market expects monetary policy normalization to continue in response to a world economy running close to capacity.

“These characteristics do not point to a gloomy economic outlook by any means -- rather, they are welcome symptoms of normalization,” Poloz said in a speech to the Canada-U.K. Chamber of Commerce in London. “Investors can no longer expect yields to be suppressed by extraordinary monetary policies.”

Optimistic View

The speech is consistent with an optimistic view of the global and Canadian economies from a central banker who has raised policy rates five times since mid-2017, making the Bank of Canada one of the most aggressive in normalizing among advanced economies.

While Poloz acknowledged there are questions about whether the central bank’s forecasts are “too rosy,” he said market developments are largely in line with the central bank’s outlook.

“When you take a broad look at financial markets, the messages they are sending appear to be generally consistent with our economic outlook and our understanding of the main risks to that outlook,” Poloz said, reiterating in his speech the Bank of Canada will need to raise rates to “a neutral stance.”

The Canadian dollar appreciated on the speech, trading 0.2 percent higher to C$1.3080 per U.S. dollar at 9:27 a.m. in Toronto.

Higher Yields

When it comes to the bond market, Poloz said said he believes a “more important signal” is not a flatter yield curve -- which is being driven by structural forces -- but the increase in higher long-term bond yields that seems to be a reversal of a long-term downward trend. That suggests investors believe the risk of deflation has been taken “off the table” and they understand they can no longer rely on loose monetary policy to suppress risk and yields. Falling stock prices, meanwhile, are simply a reaction to that.

“If investors are coming around to the view that expected earnings, as good as they are, need to be discounted by higher interest rates, it naturally lowers the price they are willing to pay for a given stock,” Poloz said.

Normalization isn’t the only factor impacting financial markets however, Poloz said. Escalating trade tensions between the U.S. and China is also having a major impact in most markets -- from commodities to debt and stocks.

For example, debt and equities of trade-exposed companies have under-performed other industries less exposed to this risk. The relative under-performance of Canada’s stock market is due to the fact it is so heavily weighted with such companies, he said.

Nor should recent weakness in commodity prices be interpreted as a signal of weakness in demand. There are specific factors such as slowing in Chinese growth amid trade disputes and pipeline capacity issues in Canada that are having an impact.

On foreign-exchange markets, Poloz said it’s “not a surprise” the U.S. dollar has outperformed given the stronger prospects for continued U.S. growth and rate increases by the Federal Reserve.

©2018 Bloomberg L.P.