In Canada, the picture seems clearer, but the US offers a murkier outlook with more variables at play.

It was over a month ago

when the Federal Reserve announced they still expected rate cuts to happen in 2024 but had to pivot based on higher-than-expected inflation numbers and an economy that projects to grow at roughly 2.1% for the year. That in contrast with the 1.4% growth that was projected in December of 2023.

The market reacted adversely, with the Dow retreating over 5% while the Nasdaq fell over 7% in the course of about a week. The reaction of the markets makes sense as the consensus is that rates will see decreases this year. But with inflation being consistently higher than expected coming into the year, that increases the chances of rate hikes or, at the very least, the length of time before a rate cut becomes realistic. This was virtually unheard of to start the year.

While the GDP in the US only grew by an annualized rate of 1.3%, the issue here becomes that despite the Fed’s desire to bring rates down, a growing economy and higher inflation numbers will simply not allow the Fed to cut rates for fears of restarting the cycle we saw come into effect in 2022. The one saving grace that has emerged in the numbers lately is that while prices are still increasing year-over-year and even month-by-month, a decrease in consumer spending may put a cap on price increases as consumer spending rose just 0.2% in April.

The core inflation number for April was still 2.8% year over year, 0.1% above the estimates and ahead of the 2.0% target the fed has deemed to be ideal. The market may look at the relative lack of surprise as a positive and spur markets to start the week come Monday.

The issue that investors face is the uncertainty from the Fed. The longer the Fed waits to announce cuts, there are likely more days of volatility coming. With many betting that the first rate comes in September at the very earliest, a further delay from there could likely accompany another downturn in the markets, reflecting unknown policy moving forward.

However, North of the border

inflation came in at 2.7% for April compared to 2.9% in March. The decline was spurred mainly by price decreases in food, services and durable goods. This, in my opinion, is good news as people don’t want to see a lower inflation number based on lower gas and energy prices. Lower inflation due to food and services, however, hopefully represents a non-cyclical decline that will help Canadians at the cash register when shopping for food for their families.

The Canadian economy grew at an annualized rate of 1.7% in Q1, compared to estimates of 2.2% from analysts and 2.8% from the Bank of Canada. Further, the Q4 GDP growth rate from the end of 2023 was revised down to 0.1% from 1.0% as originally reported. These are signs that the Canadian economy is slowing down and while not a recession, I believe it all but ends the rhetoric of maintaining a new normal of relatively high rates for longer in Canada. “Bets” for a June 5^th rate cut have increased from 66% to 83%.

With a rate cut looking like more of a certainty in Canada. Here’s what you can expect to see play out after the announcement. Yields on existing bonds in the market will fall with their prices increasing as the bonds that are offered tomorrow should be yielding lower than the bonds on offer yesterday, while the interest Canadians are earning on their High-Interest-Savings-Accounts will almost certainly fall to the same extent of the rates themselves. This will likely lead to Canadians moving away from their HISAs and into stocks and bonds. The reason being, if say, rate cuts continue quarterly throughout the remainder of the year the risk/reward profile between the asset classes begins to separate more and more. What was once a very attractive yield opportunity at 4.5%+ with principal protection becomes lower and lower as rates continue to fall. Investors will likely take the opportunity to jump into more attractive dividend payers or bonds before rates get too low and prices on existing bonds get too high.

In our opinion, the time to move into bonds and fixed income is here. With yields dropping, prices have already started to turn up in the bond market. Usually, investors don’t look at bonds as an effective way to earn capital appreciation but with cuts in Canada all but certain this summer, bonds offer an attractive way to create income and potentially capital gains while moving money out of an asset (HISAs) that has provided stable income and certainty since 2022 but looks less attractive moving forward.

As an aside, value plays in Canada look to be Utilities, which have been battered due to higher rates making their dividends less attractive and Canadian banks, especially TD and BMO that have seen rough quarterly earnings reports send stock prices down. Rate cuts will make utility dividends more attractive and should contribute to more mortgage business for banks along with easing potential delinquencies amongst customers most affected by the higher rates.

In short…..

Expect longer runway and more questions on a rate cut in the US, which could lead to short-term volatility and potential to move USD Cash into attractive stock opportunities. A rate cut come June 5th is looking like more of a certainty in Canada than a question at this point. This could weaken the CDN dollar vs the American, allowing for Canadian investors to potentially enjoy a bump in value amongst their US stocks in CDN dollars. We believe that any short-term volatility caused by news surrounding or acts directly affecting interest rates represent nothing more than an opportunity to deploy the Cash in HISAs into investments that offer more potential long-term return. Use these opportunities to continue to build out your strategy as dictated by your long-term goals. As always, reach out with any potential questions you may have.

Chat again in July! 

This information has been prepared by James Hogan, who is a Portfolio Manager for iA Private Wealth Inc. and does not necessarily reflect the opinion of iA Private Wealth. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Portfolio Manager can open accounts only in the provinces in which they are registered.

iA Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Canadian Investment Regulatory Organization. iA Private Wealth is a trademark and business name under which iA Private Wealth Inc. operates.