Advisor explains subdued market reaction to BoC cut

By the time the Bank of Canada cut interest rates by 25 basis points yesterday, that likelihood was 90 per cent priced into the market. After months of speculation about interest rate cuts, which sometimes took the tone of prayers to BoC Governor Tiff Macklem, the first cut since 2020 came not with a bang but with a shrug and a ‘what’s next’ from markets.

Kevin Burkett, portfolio manager at Burkett Asset Management, explains why markets had already priced in a cut and how such a heavily covered and hyped decision came to be so easily digested by investors. He outlined some of the opportunity sets for investors that may now be on course to change due to the start of a cutting cycle but drove home that while the media likes to make a lot of noise about a single monthly decision, the reality that advisors and their clients have to deal with changes gradually, day to day.

“An announcement like yesterday’s has this false sense of tremendous impact, where if you look at markets and where things are priced the impact is really very little,” Burkett says. “What matters more than the monthly announcements is the path of those decisions relative to what markets expect.”

The path of rate cuts in Canada, Burkett says, should make bonds look more attractive from a total return standpoint as they lock in 4.5 to 5 per cent rates on safe assets. He says that clients who had hesitated to rebalance from equities into bonds may find that the ship has sailed on these yields by the end of this year.

Burkett expects a gradual and somewhat subdued reaction to rate cuts going forward, too. BoC Governor Tiff Macklem signalled that further rate cuts are likely striking a dovish tone while remaining committed to data-dependency. Those cuts will be priced in gradually, leaving advisors to offer their clients nuance and context around why their mortgage renewal rate hasn’t shot down by 25 basis points in a single day.

One area of interest to Burkett from this announcement is the potential of some divergence between the Bank of Canada and the US Federal Reserve. The Fed meeting is set for next week, but markets have put the likelihood of a cut as very low. Canadian monetary policy rarely diverges from the Fed by a significant amount, so the question now arises of how deep Macklem can cut while the Fed holds, and whether those cuts will have a serious negative impact on the value of CAD.

While that cross-border factor is a key area Burkett is watching, he believes that many advisors and investors attribute too much of the market and macroeconomic landscape to individual central bank decisions. Many clients, he says, will come to their advisors confused about the overall impact of these decisions because the media seems to have such a singular focus on macroeconomic indicators and the outlook for interest rate cuts or hikes. Demonstrating what these monthly decisions actually mean, and how a client’s portfolio may already reflect the expected outcome before a decision is made, can be an opportunity for advisors to demonstrate their value.

Some of the current confusion and almost messianic language around interest rate policy stems from the COVID-19 pandemic. The dramatic nature of interest rate cuts at the onset of the pandemic, followed by the subsequently dramatic hikes we saw as inflation roared and vaccine rollouts completed, has left investors and clients with a degree of whiplash.

“Now we have the question of ‘where do we go from here?’ wither we will get a soft landing or a hard landing or no landing, all this discussion and all the buzzwords coming out of it gives a very valse sense of the degree of control of the economy that monetary policy actors can have,” Burkett says. “Whether that discussion lands with an end client, I’m not sure. But it’s definitely making the job of a coherent, consistent, conservative portfolio manager more and more difficult.”

That is not to say Burkett believes advisors need to disregard macroeconomics. The direction of rates is instructive, so too are demographic trends like population aging and immigration. However, the true macroeconomic picture is deeply nuanced and influenced by myriad factors. It’s on advisors to ensure that they help their clients understand the context in which they are investing.

“I think portfolio managers should be leery of trying to make precise calls on where interest rates are headed,” Burkett says. “I think it’s better to focus instead on helping clients understand what these interest rate announcements really mean.”