Is an October interest rate cut now on the cards?

Uncertainty continues to reign over the Bank of Canada’s interest rate policy after its decision to keep the overnight rate at 1.75%.

Stronger domestic data was countered by escalating trade conflicts “taking their toll” on both the global and domestic economy, meaning that despite other central banks taking a more dovish stance, Governor Stephen Poloz opted to stick rather than twist.

Sean Harrell, partner and senior advisor at Howe, Harrell & Associates, said the picture was far from clear cut, although suggested that an October cut was now most likely. He told WP he remained concerned that the heralded economic growth in Canada is due, in a large part, to immigration and that per capita growth has actually been stagnant.

He told WP: “It’s concerning that they are pulling the wool over people's eyes by saying the economy is growing by 3-3.5%. When you peel back the layers, it’s actually not growing at all. That’s a little bit of a concern for us, which suggests there maybe should have been a rate cut.”

He also pointed to red flags like inverted bond yields and employment rates but acknowledged there is another side to the argument.

“The markets are not doing too bad. We haven't had a major pullback in 11 years and interest rates are already at all-time lows, so how far do you go? Do you keep cutting? I’m of the opinion that they’ve got to cut them at some point and I subscribe to the Big Brother mentality down in the United States; that what happens down there, we just tend to follow along.”

Rather than obsess over trade war rammifications, although Harrell conceded that Canada will share the brunt of it for a while, he’d rather the country focused on things it actually has control over, like addressing the porblems in the energy sector.

The global uncertainty lingers, though, and he has positioned his portfolio more on the safety side. That’s meant a slight change over the past six months, taking on more of a corporate bond strategy.

He remains a believer that we are due a sizeable pullback and that it’s a good time for floating rates or corporate bonds because if interest rates fall, Canadian bonds are going to do well.

He added: “If you select the right ones, they’ll produce decent yields of between 4-5%. With all this uncertainty going on right now, especially the clients approaching retirement, they're happy with that 4-5% yield. So, we’ve been implementing a few more bonds than we normally have into our portfolios.”

A slow and steady rate increase is Harrell’s preferred path forward – a move that would show a whole lot of confidence in the markets and in what the government’s doing. It would also curtail some spending, which would be good from a personal debt level. A rate decrease in October could spark renewed concerns about the housing market, with young people having cheap money at their disposal that leaves them at risk of overstretching.

“That won’t rear its ugly head for five or 10 years kind of thing," he said. "But I think there could be a huge problem in five to 10 years if our interest rates stay this low. I don't know what the government will do, maybe they'll step in and try to change the down payments for houses again, or try to curtail it in a different manner instead of just flat out interest rates.

“These young couples are buying these massive homes that they can just barely afford it at the current rates. In five to 10 years, when the fallout starts, cash is going to be king and people will able to buy up properties because I don't think the younger generations are going to be able to sustain it if we have a 1-2% interest rate jump.”