Page and Associates Ltd.

Family Wealth Management

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Short Term Pain for Long Term Gain

In the wake of the Bank of Canada’s surprising the market with a 1.00% hike of its overnight rate, CIBC Deputy Chief Economist Benjamin Tal provided a 4 minute video of his outlook on inflation, interest rates and the economy, and how investors should view these developments.

Key points:

  • Inflation should not be our main concern, because there are forces that will bring it back to more moderate levels. We should be more concerned about the cost to the economy of getting it back down.
  • The Bank of Canada’s goal is not to prevent recessions, but to limit inflation expectations to avoid a destructive wage-price spiral.
  • There is a 40-45% chance the bank will hike rates more than it needs to and cause a recession. They have signaled they want to go from 2.5% up to between 3 and 3.5%, but the difference between 3% and 3.5% may be the difference between a slowdown and a recession.
  • Inflation is a lagging indicator and usually peaks 4 to 6 months after the start of a recession, but no central banker will resist increasing interest rates when inflation rates are high.
  • Every recession in the past 40 years (except Covid) was helped – if not caused – by central banks hiking rates higher than they needed to.
  • There is still a good chance they won’t overshoot this time, because the significant increase from Covid-era lows are already starting to be effective at curbing demand, and there is still lots of strength to support growth.
  • So the rate hikes are probably already slowing growth, and if we do end up in a recession, it should be short and mild because
    o We have record high job vacancies
    o Consumers are sitting on about $300 billion in excess cash
    o The housing market is undersupplied and should support growth for years
  • Covid job losses were mostly lower income, higher earners took advantage of low interest rates to buy housing, so we borrowed some growth from the future
    o 20-25% home price declines would not be surprising
    o Rents did not rise during the pandemic, but they are rising now
    o Construction costs have risen faster than condo prices, so this sector is slowing now, but will rebound once supply and demand are back in balance
  • Equity markets have already priced in a lot of the bad news, and may have priced in more interest rate hikes than will be required.
    o If you have limited time horizon, equities are still risky
    o If your time horizon is 2-3 years, there are a lot of good opportunities out there.

Link to Video: https://link.videoplatform.limelight.com/media/?mediaId=3d73878551b043c7a33bd5f0ccbf09f9&width=540&height=321&playerForm=LVPPlayer&embedMode=html&htmlPlayerFilename=limelightjs-player.js&orgid=7e36bf0095db492cb2c8179d58eb0e29

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Bank of Canada Increases Overnight Rate to 2.5%

Today, the Bank of Canada surprised markets with a 100 basis point (1%) increase in its target overnight lending rate to 2.5%. (Press Release: Bank of Canada increases policy interest rate by 100 basis points, continues quantitative tightening – Bank of Canada).

Markets had been expecting another 0.75% increase based on the bank’s comments in May that it expected the neutral rate (neither stimulative nor restrictive to economic growth) to be about 2.5%, but that it would re-evaluate this target based on inflation and other statistics. Inflation has remained persistent in the face of ongoing supply chain disruptions, Chinese COVID lockdowns, and the war in Ukraine, and job vacancies remain at record highs without sufficient labour force to meet the demand surge after this year’s re-opening.

The Bank of Canada said this week that the neutral rate may need to go to 3-3.5% to balance demand to available supply, and the economy was strong enough to absorb the interest rate increases without causing a recession, so it wanted to ‘front load’ the rate increases to reduce inflation pressures immediately, and avoid even higher targets being needed in the long term. We should therefore expect a further rate increase at the bank’s next meeting September 9th, and at the next US Federal Reserve meeting July 26-27.

While the bank does not believe the higher rates will cause a recession, they do expect economic growth to slow. Still, their expectations are for reasonable growth rates of 3.5% this year, 1.75% in 2023, and 2.5% in 2024. Because inflation measures price changes from past levels, they expect about 8% inflation readings for the balance of the year, but a return to 3% by the end of 2023.

Bond markets had anticipated further rate increases so their yields and prices had already adjusted before the announcement. Top GIC rates are now over 4% for a 1-year term, and top daily interest deposit rates of 1.3% may see an increase in the coming days.

Video summary: Monetary Policy Report – July 2022 – Bank of Canada
Full Report: Monetary Policy Report – July 2022 (bankofcanada.ca)

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Peak Inflation? Annual Rate still high, but monthly rate declines in April.

The US Bureau of Labor Statistics today released Consumer Price Index (CPI) data for the month of April, showing seasonally-adjusted price increase of only 0.3% from March levels. This reaffirms the view of some commentators that inflation should naturally slow from recent record year-over-year rebounds from pandemic-induced price decreases in 2020.

The graph below shows the month-over-month price level change, which has hovered between 0 and 0.5% per month for the past 5-10 years. You can see the negative inflation in 2020 March – May, which took CPI down 1.2% during that period, limiting total annual inflation to only 1.2% for the year. 2021 made up for that as demand for goods surged amid pandemic restrictions on services, and covid-induced supply chain disruption, with a 7% total inflation for the year. Those supply chain disruptions continue into 2022: first quarter 2022 inflation has been just shy of 3%, with 1.2% of that in March alone, with the conflict in Ukraine spiking oil and energy costs, which are feeding through to the price of all goods and services that use them.

(Source: Bureau of Labor Statistics https://www.bls.gov/cpi/latest-numbers.htm )

Some goods prices have started to decline as their supplies become more balanced, used car prices being one example. Historically, oil prices have not stayed much over $100 per barrel for long, and even if they stay at that level, at least they would not contribute directly to further inflation in coming periods. For this reason, some analysts believe we have seen the peak in monthly inflation at 8.5% in March, and that the year-over-year figure, down to 8.3% in April, will continue to moderate as the year continues. This may take some pressure off central banks on the need for interest rate increases.