It’s notoriously difficult for central banks to find the right level of interest rates to cool inflation without pushing the economy into recession. Judging by recent data, it appears the Bank of Canada might be pulling off this tricky job and bringing the economy in for a soft landing.
The bank hiked rates 10 times in just 18 months, the fastest pace of tightening in Canadian history. Those increases took the bank’s policy rate to 5% from 0.25% and have done their intended work of bringing down inflation, with the help of events elsewhere in the world.
The consumer price index fell to 2.8%1 in June, placing it within in the bank’s 1 to 3% target range and marking a huge improvement from June 2022 when the inflation rate topped out at 8.1%. Despite the rate increases, employment has remained strong and economic growth positive.
It’s a similar story in the U.S. where the Federal Reserve has ratcheted rates up aggressively and been rewarded by a significantly lower inflation rate – 3%2 in June. The economy south of the border continues to be in good shape with a 3.6% unemployment rate and moderate GDP growth.
The markets have also been resilient in the face of higher interest rates. In the first half of 2023, North American stock markets have climbed the wall of worry despite banking system and US debt ceiling fears. International and emerging markets were also in positive territory. For more detail, have a look at Ray Kerzerho’s economic and market commentary.
The pandemic was the source of much of the surge in inflation around the world. Consumers who were flush with cash from lockdowns were anxious to spend, putting upward pressure on prices. Supply chain disruptions and Russia’s invasion of Ukraine also contributed to higher consumer prices.
Now, consumer spending has softened, the kinks have been ironed out of supply chains and the impact of the war in Ukraine on commodity prices has eased (although the impact of the Russia withdrawal from the Black Sea grain export deal remains to be seen).
So, has the battle against inflation been won? Certainly, the Bank of Canada isn’t ready to declare victory. While many economists are predicting the bank’s rate hike on July 7 will be its last in this tightening cycle, Governor Tiff Macklem has been conspicuously silent on what comes next.
We don’t try to predict the future direction of interest rates. Instead, we prefer to focus on controlling risk. In the current context, one important risk we’re watching is the possibility that rates will stay higher for longer than many observers currently expect.
Earlier this year, some pundits were counselling investors to bet on rates beginning to fall. It hasn’t worked out that way yet. Rates in the bond market actually rose. We made a prudent move to shorter bond maturities last year and we will be cautious about taking on longer bond durations now.
Another key risk is personal debt. Mortgage and consumer debt have become a lot more expensive over the last 18 months and could remain that way for longer than you anticipate. Reducing debt when possible and being careful about new borrowing are good risk-reduction moves in a higher rate environment.
While prospects may look good for a soft landing now, it’s always smart to hope for the best, but plan for the unexpected.
Team news
Over the past few weeks, the team has been working hard to deliver the performance reports that you’ve now received through the PWL Wealth Centre or in the mail. As you know, we don’t jump on bandwagons or try to catch the latest hype. In the first half of this year, that has manifested itself in the excitement surrounding artificial intelligence. In the short run, markets thrive on expectations, and AI has certainly created some exuberant expectations. In the long run, economic reality ultimately dictates returns. This is why value investing ultimately wins, as long as we stay disciplined against the fear of missing out.
Outside of the office, we continue to be active in the community supporting various causes, including:
The Douglas Foundation supports mental health research and care at the Douglas Research Institute, which is the second largest mental health research center in Canada. In addition to sponsoring their Open Minds Gala in March, I am putting together a team for their Bromont Ultra fundraiser. If anyone wants to participate in a 160km mountain bike relay race, let me know!
The Depot Community Food Centre takes a multi-faceted approach to food insecurity in Montreal. The Depot runs community gardening programs, pop-up fresh produce markets, cooking classes and a restaurant for free drop-in meals. It also runs the innovative Marché Dépot where participants can ‘shop’ with Depot Dollars to supplement their groceries in difficult times. As Chair of the Board for this organization, I can attest to the amazing team at Depot and the important work they do.
I hope everyone is having a great summer, despite the challenging weather across the country.
As always, feel free to reach out if you have any questions.
Best regards,
Peter
1 Source: Bank of Canada
2 Source: Bureau of Labor Statistics