08:01 AM EST, 01/15/2025 (MT Newswires) -- The speech this Thursday on balance sheet normalization by Bank of Canada Deputy Governor Toni Gravelle has brought the discussion on quantitative tightening (QT) end timing and how the Bank of Canada will add replacement assets back to the forefront of market participants' minds, said RBC.

The bank thinks the steady-state level of Lynx balances has already been reached and QT should be ending. The BoC has noted recently that any change in its QT stance would be preceded by a further discussion on how it would conduct regular balance sheet operations going forward.

RBC expects Thursday's speech to provide that further information and for the BoC to end QT as soon as the Jan. 29 policy meeting. In addition, Jan. 29 is the last meeting before a March 1 maturity of C$12 billion that rolls off the BoC's balance sheet.

BoC Deputy Governor Gravelle gave a relevant balance sheet speech in March last year where he outlined that the BoC would use an ALM approach to manage its balance sheet when QT ended. That means matching floating rate liabilities (Lynx and Government of Canada cash balance) with bills and term repos, while the currency note liability would be matched by the bond portfolio.

As Gravelle outlined in the speech, with BoC assets almost entirely made up of bonds currently, Canada's central bank will focus on shortening duration through term repos and bills, with bond purchases (for liability management) coming later. Based on the size and maturity profile of the bond portfolio relative to the currency liability, it could be several years before bonds are purchased, though the BoC may prefer starting earlier than that at low levels -- especially for shorter-dated bonds, which present a gap on the balance sheet, stated RBC.

While the general sequencing of adding replacement assets is clear, the method of purchases between primary and secondary market for bills and bonds wasn't, added the bank. Its expectation is that to reinforce the return to normal messaging, the BoC will decide to purchase bills and bonds at auction, as it did pre-pandemic, for regular balance sheet management. This is also the most straight-forward, market-neutral, and operationally simplistic approach.

For term repos -- likely the first used for replacement assets -- the uncertainty is regarding the term and collateral used. They extended out to two-year terms during the pandemic and accepted a broad range of private corporate collateral. However, RBC expects the BoC to do something more like the one- and three-month terms and the federal and provincial government and guaranteed collateral used pre-pandemic.

For the total balance sheet size, the bank estimates a C$280 billion size -- roughly equivalent to the current asset level, including ORs -- with half of this in term repos and bills and the other half in bonds. For bills, a range of C$45 billion-C$60 billion (15%-20% of a C$300 billion stock) would be a reasonable steady state, though that would likely be reached over several years given the bond maturity profile and initial purchases would be more likely in the 5%-10% range.

A steady state for term repos is likely in the C$80 billion-C$100 billion range, though again this would take many years to reach. For bonds, RBC sees little reason for an early, broad-based purchase program given the shift to an ALM approach, but could see the BoC start buying two-year bonds earlier than other maturities to help smooth out the bond maturity profile by adding maturities for 2027-2029.

Given the bank's expectations on the timing of bond purchases, the end of QT isn't likely a game-changer for term swap spreads, which have continued to tighten -- cash cheapen versus swaps.