pabradyphoto
Bank of Canada raised overnight lending rate by 50 bps, lower than the 75 bps hike that the street was anticipating. Could the U.S. Fed surprise next week and signal a less hawkish direction? Kim Parlee speaks with Alex Gorewicz, Portfolio Manager, Active Fixed Income, TD Asset Management.
Kim Parlee: Is there anything we can take from the Bank of Canada today to say that it might be some hint that maybe they’re going a little softer, perhaps, on the rate hikes? Could we see the same thing happening with the Fed?
Alex Gorewicz: Not at the moment. And really, if we compare the level of inflation and the rate with which inflation is changing and the composition of it in the US versus Canada, there is a lot more strength in the US. So if the Bank of Canada isn’t ready to talk about a pivot, the Fed is certainly a lot further away from that. But when we think about laying the groundwork for the fact that now interest rates, or the policy rate, is in a much more restrictive territory for the US economy, and every additional rate hike will put them further in that restrictive territory, we should anticipate that they’re going to lay the groundwork for how they’re going to slow the pace of rate hikes. So even if their next rate hike will be 75 basis points, they might communicate that now it’s time we slow that pace. But slowing the pace doesn’t change the fact that interest rates will continue to go higher.
Kim Parlee: Yeah. Yeah. Just not as quickly, perhaps, but still pretty darn fast.
Alex Gorewicz: That’s right.
Kim Parlee: What about other central banks around the world? I mean, what are you seeing there in terms of what cues they’re taking?
Alex Gorewicz: Well, there isn’t a consistent theme. A lot of things feel like they’re breaking for different reasons. So if we look at China, for example, the way that they address COVID outbreaks, their zero-COVID tolerance, is impacting economic activity today and dampening sentiment about continued economic activity into the future. But this is also weighing, for example, on other Asian economies that have large exposure to the Chinese economy. And so the outcome is that currencies in these markets are depreciating, or tumbling, relative to the US dollar. Then we have Japan as another example. The economy is doing well. Inflation is higher than where they’ve seen it for a long time but still very low relative to, call it, the global average experience with inflation over the last year. And so Bank of Japan actually has never tightened monetary policy. They’ve kept it extremely easy, or accommodative, but that has also put additional pressure on the Japanese yen, on their currency, relative to the US dollar. Same thing with Europe. If we look at what’s happening with Swiss banks, if we look at what’s happened in UK, there are a number of idiosyncratic factors that are manifesting themselves in different markets that are all resulting in this sort of flight to safety, and value, and security that the US dollar provides.
Kim Parlee: That’s so tricky for the Fed as well, too, because they have to manage their own economy. And they’re going to raise rates to do what they need to do to cool inflation or activity in general, which puts upward pressure on the dollar. Plus you have the insecurity elsewhere, which puts upward pressure on the dollar. So what point does the Fed ever take that into consideration? They have domestic policy they need to think about. But if other partners are going to default on debt, that has an impact too.
Alex Gorewicz: Well, hopefully we’re not talking about defaulting on debt when it comes to a big–
Kim Parlee: In theory.
Alex Gorewicz: That’s right — when it comes to a big economy like the UK. But what happens is when– let’s take the UK, for example. When the crisis emerged, when interest rates started moving very high and the pension system was at risk, eventually the government tumbled as well. When we look at these dynamics, the way that they choose to address or to implement policy domestically ends up putting additional pressure on the US dollar, ends up putting additional pressure on US interest rates. But that feeds back into the real economy in the US because higher interest rates mean, well, financial assets probably get revalued lower. So then anyone who has savings in financial assets feels a little bit less wealthy. Interest rates moving higher means that companies that need additional money, need to raise additional money, are doing so at much higher costs. Well, that means that they’re going to perhaps slash business investment. So now you’re starting to see businesses also curb their spending. Then we also have the housing channel. Higher interest rates mean mortgage rates are substantially higher, and they are. They haven’t been this high in the US since, I believe, 2007, or perhaps even 2006. And all of that will end up feeding into house prices going down, people feeling less wealthy, spending less, saving more. All of that ends up having real economic impact on the US because of what is happening external to the US and how central banks and governments are choosing to address the domestic issues that they face.
Kim Parlee: Let’s finish with some bright spots. So I was going to say– in collapse with that, I’d say is that we’ve seen what’s been happening with bond yields. And maybe for an investor, what kinds of things can they be taking advantage of in a situation like this?
Alex Gorewicz: Well, to tie back to what we’ve been talking about, interest rates have moved a lot higher than they probably should if we were just to treat the US in a vacuum and say, well, what does the economy look like, what are the monetary policy settings from the Fed, and where should interest rates be when taking all of that into account? But because they’ve been pushed higher by what’s happening in the rest of the world, government bond yields look really attractive. And they haven’t looked this attractive in a very long time. On the downside, it means perhaps risk assets like stocks are still a little bit overvalued at current levels. But government bond yields from a valuation perspective look very attractive. And if nothing else, even if you don’t get capital appreciation over the next 12 months because the Fed’s not ready to pivot, you will get income that you haven’t seen in a long time.
Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.
Be the first to comment