Why markets need to cool their jets over rate-hike expectations

The Bank of Canada’s second rate hike this year - this time a 50 basis points increase - wasn’t a surprise to the financial industry.

“Inflation is at very high levels, so it’s no surprise to see the Bank of Canada raising its rates,” Adam Murl, Vice-President of Retail Research and Portfolio Manager for Guardian Capital LP, told Wealth Professional.

“At this point, it’s in line with our expectations and we expect continued hikes through the year. But, we also think that inflation may have just peaked on a year-by-year basis, and should moderate, and then we’ll just have to wait and see how the data points come in through the summer and go from there.”

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The Bank of Canada yesterday increased its target for the overnight rate to 1% with the bank rate at 1.25% and the deposit rate at 1%. That was the first 50-basis point rate increase in 22 yeas as Governor Tiff Macklem attempts to cool the housing market and tame the three-decade high inflation. Inflation rose to 5.7% in February, up from 5.1% in January. March’s inflation rates are expected to be released next week.

This hike makes Canada the first in the G7 countries to raise rates by 0.5%, which markets now expected to hit 3% by this time next year.

Murl said Guardian’s fixed-income team thinks the market may potentially be a bit ahead of the Bank of Canada.

“So, we expect market expectations might have to come down a little bit,” he said, “although, we obviously expect the hiking cycle to take place, but maybe not to the extent that markets currently expect.”

Janine Guenther, President of Dixon Mitchell Investment Counsel in Vancouver, noted that interest rates are not as high as they were in the 1980s. But, she said if the current interest rates keep increasing, it’s really important to have the right mix in portfolios.

“You want to be skewed more towards dividends because those have a little bit of inflation protection, much more than bonds in your portfolio,” she said.

Guenther also noted that there’s been a dramatic move in the bond market, foreshadowing big changes in the North American interest rates – more than what she said the Federal Reserve has been talking about. That, coupled with the supply chain disruption from the pandemic, a massive lockdown in Shanghai, the war in Ukraine, and the expectation that Europe will go into a recession sometime this year, is having an impact.

“Maybe this is a natural way out of a high growth environment to a slower growth environment,” she said. “So, maybe there won’t be as many increases in interest rates as we thought there were going to be, particularly in Europe.

“In North America, things have never been better. We have full employment, but we have higher interest rates and a little bit of inflation. We’ve had a recovery from the pandemic in two years, when it took us 10 years to recover from the 2007-2008 problem.

“So, I think, from a financial advisory perspective, we have to make sure that we help our clients not stay anchored on current events, but think about things in the long-term so that we can keep them invested because we don’t want them getting out of the market. We want them to be able to keep investing in a way that’s going to keep their wealth stable until we make it to the next leg of growth in the market.”