stephen s poloz : making sense of markets remarks by mr stephen s poloz, governor of the bank of canada, to the canada – uk chamber of commerce, london, united kingdom, 5 november 2018. * * * introduction making sense of financial markets is supposed to be easy. stock prices, bond yields and exchange rates are all expected to behave in line with economic fundamentals. we know the reality is more complicated than that. yes, financial markets react to new information — in fact, they usually overreact. today ’ s overreaction becomes tomorrow ’ s retracement, and so on. it can be very difficult to reconcile high - frequency financial market action with slower - moving economic fundamentals. often this process of reconciliation is just a matter of time, since economic data arrive with a lag while financial markets live in the moment. but therein lies the essential problem : our view of today ’ s economic fundamentals is actually a forecast because the data have not arrived yet. if financial markets appear to diverge from those forecasted fundamentals, they may be telling us that our forecast is wrong. the fact that financial market prices are formed with the discipline that comes from putting real money on the line means that central bankers ignore them at their peril. to illustrate the difficulty, consider some of the market action we have seen in 2018. yield curves were on a flattening trend in the first half of the year, raising questions about whether they were pointing to slower economic growth ahead. at the same time, stock markets were on a steady march upward, which we would normally associate with a positive economic outlook. this fall, we have seen the reverse — higher yields and widespread stock market declines. while it may not always be possible to make sense of all this, the effort itself is generally worthwhile. today, i want to touch on some of the main points of our latest outlook, and offer some reconciliation of recent financial market action with that view. of course, there are always risks in trying to interpret what financial markets are saying. markets are not monolithic — their prices represent the average of a diverse distribution of views. moreover, markets evolve over time. still, we glean what we can from markets and use the information to cross - validate the signs we see in the economy. the economic outlook let us discuss the economic outlook briefly. the big picture is that the world has made considerable progress in shaking off the effects of the 2007 – 08

- term yields in recent years. that means short - term yields do not have to rise as far as in the past to flatten or invert the yield curve. one of these factors is that the neutral interest rate has been drifting downward for about 15 years, contributing to a long - term trend toward lower bond yields. a second factor is that years of successful inflation targeting by central banks have reduced inflation risk steadily. a third factor has been the buying of bonds by central banks as part of efforts to mitigate the effects of the global financial crisis. in light of these factors, it seems that the more important signal coming from the bond market is not a flattening of the yield curve, but the reversal in the long - standing downward trend in longterm yields. indeed, since the start of the year, the us 5 - year yield has risen by more than threequarters of a per cent, to over 3 per cent, while the 10 - year yield has climbed by a similar amount, to about 3. 1 per cent. this trend reversal is consistent with the view that a decade of massive monetary policy intervention is finally taking the risk of deflation off the table. higher bond yields may reflect that the market is becoming two - sided again, as central banks shift interest rate risk back out into the marketplace. investors can no longer expect yields to be suppressed by extraordinary monetary policies. within this big - picture theme, some important sub - themes are emerging. one is a worrying tendency among some emerging markets to encroach on the independence of their central banks. another is the consequences for the corporate bond market. corporate yields and spreads have for some time been compressed by the post - crisis provision of central bank liquidity, and the trend shift is leading to modestly wider spreads now, as we would expect. importantly, though, these effects are not uniform across the market — debt issued by companies most exposed to international trade actions is underperforming other sectors. specifically, since 2 / 5 bis central bankers'speeches the start of the year, the spread on debt issued by basic materials and industrial companies has widened two to three times as much as that on the debt of technology companies. these differences in spreads can be seen globally and tell us that investors see growing risks for these firms in light of international trade actions already taken or in prospect. i mentioned that most countries are not as far advanced in post - crisis recovery as the united states. however, because bond