"I think the tightening cycle is over"

Last week we gained a clearer picture of where the Canadian economy sits. Q3 GDP shrank by 1.1%, faster than analysts expected. Labour market figures came in down in real terms. Consumer spending has been sluggish for the past six months. Inflation, notably, has fallen closer to the central bank target rate. Tomorrow the Bank of Canada will make its last interest rate decision of 2023 and Myles Zyblock believes that we won’t see another hike from the BoC anytime soon.

The Chief Investment Strategist at Dynamic Funds explained that some key indicators of Canadian economic health paint an even worse picture than those topline datapoints published last week. Government spending, for example, contributed about 1.2% to Canadian GDP in Q3, meaning if spending was flat, that downturn would look far worse. He cited a sluggish export market given global slowdowns, and noted the potential for structural weakness in commercial real estate.

Zyblock highlighted some of the strategies and allocations that can look more attractive now and outlined ways advisors might want to contextualize this economic news for their clients. While he cannot predict when the Bank of Canada will cut rates, he argued that the central bank hiking cycle is having its intended effect and further hikes should be unnecessary.

“I think the tightening cycle is over,” Zyblock says. “They’ve moved up rates pretty dramatically over the past two years and I’d say they’re probably done. If you look at the financial markets they’re expecting some substantial rate cuts out of the Bank of Canada in 2024. At this next meeting they could tip their hat to something that’s a little bit different than what the markets expect, but somewhere around one percentage point of rate cuts is expected over the course of 2024.”

Zyblock says that BoC commentary emerging from tomorrow’s announcement will give greater clarity around if and when the central bank will cut rates. Inflation has been the watchword throughout this hiking cycle, so if we see commentary that meaningfully states a belief that inflation is moderating that should be a good sign. A shift away from inflation to a mention of concerns around slowing growth could be even more indicative of a looming rate cut.

On the other hand, if there isn’t much noise made about growth and we continue to hear concerns around inflation we may see the ‘higher for longer’ thesis continue to play out. Zyblock cites the example of Sweden, which has a struggling real estate sector and an economy contracting faster than Canada’s, but the central bank has not cut rates.

The BoC decision isn’t happening in a vacuum, and Canada is one of the 41-42% of global economies that are currently contracting. In a global slowdown, Zyblock and the Dynamic team have broadly followed a slight underweight in equities, neutral in alternatives, and a slight overweight in fixed income. After three difficult years for fixed income, Zyblock now sees greater opportunity as we hit what he believes is peak yields. Where investors over the past three years were well served to sell weakness in bonds, he now thinks that any short-term weakness is an opportunity to acquire.

Despite an underweight in equities, Zyblock doesn’t think advisors should be abandoning the asset class wholesale. Diversification and appropriate marginal shifts are key to success. Even Canadian equities, which have struggled this year due to their overweight in financials and energy and underweight in tech, can be a contributor. Zyblock spends more time, however, focused on larger global markets like the US as they reflect a greater percentage of his global strategic mandate.

As advisors talk through both weak economic performance and the central bank’s decision tomorrow, Zyblock reiterates that so far much of what we’ve seen has been relatively predictable. While there is pain in the short-term, there are opportunities within key asset classes and reining in inflation should result in a better trajectory going forward.

“None of this should be a surprise. We’ve had a year and a half of central bank tightening, growth is going to slow, that was the plan from the outset,” Zyblock says. “You needed growth to slow to get this inflation risk lower and growth is now slowing… You’ve got to remember that inflation tends not to be good for investments either. If you look back in the late 60s and 70s when you had accelerating global inflation, most asset classes struggled for 10+ years, and we’ve gone through a struggle here for the last couple years no question, but it’s better to do this, take some of the pain upfront, correct the issue and move forward with a better long-term runway. Hopefully that’s what’s going on.”