Unpacking the significance of a 50 basis point cut and the prospect of slow economic growth
The Bank of Canada’s decision to cut its overnight interest rate by 50 basis points was as significant as it was expected. Following on from a shockingly low CPI print, most analysts and investors had priced in this ‘double’ cut. Nevertheless, the fact of a 50 basis point cut is significant in and of itself, as usually cuts of this size occur when the central bank sees a meaningful growth scare ahead.
In fact, the announcement of the cut came with forecasts for the Canadian economy from the BoC. The central bank predicts very slow growth this year, with a gradual pickup in growth over the next two years, without GDP growth ever crossing above 3 per cent. Chris McHaney, EVP and head of investment management and strategy at Global X Canada, explained why this move matters and how asset managers may want to be viewing the Canadian economy going forward.
“50 basis point cuts are typically reserved for emergency scenarios, but what might be a little different this time is the high level of rates that we’re coming from,” McHaney says. “Obviously there have been some jumbo increases on the way up, so it makes sense for there to be some jumbo decreases on the way down.”
While the absolute number always grabs headlines, McHaney accepts that the context of a starting point is key. A 50 basis point cut from a neutral rate of around 2-2.5 per cent would signal a massive growth scare. A 50 basis point cut from 4.25 per cent — which McHaney typifies as ‘restrictive’ — does not come with the same level of significance. Moreover, he doesn’t believe this cut should come as a ‘told you so’ moment for those analysts who had called for earlier and steeper cuts. He lauds the BoC and Governor Tiff Macklem for being data-driven on this decision.
Because the decision was priced in, the immediate market reaction was not particularly significant. Moreover, a consensus appears to have formed that we will get at least one more 25 basis point cut in December. McHaney says, however, that investors are currently split on the prospect of whether we get another 50 basis point cut at the final meeting of the year.
Underpinning all this discussion around future cuts is the likelihood that Canadian economic growth remains somewhat anaemic, even if we avoid a recession. Even if rates are still in somewhat restrictive territory, McHaney believes that there should be a stimulative impact from these cuts. Myriad variables beyond the BoC’s control, such as immigration and the upcoming US election, will likely have an uncertain impact. McHaney says that for now we need to watch and see if Canada’s economy can grow in a more balanced monetary situation.
In that uncertain growth environment, McHaney believes investors ought to “high grade” their portfolios. In equities, he sees strength in those businesses which have shown strong growth traits during every part of the business cycle. Low growth is not a recession, but it’s an environment where McHaney believes companies with lower debt earnings and consistent earnings streams can offer solid prospects for investors. Dividends, too, can prove a useful contributor to returns in these moments and dividends are one area where Canadian stocks tend to outperform US-listed names. Conversely, consumer discretionary stocks tend to show more sensitivity to GDP growth, which McHaney says could be a less attractive quality in this environment.
With cuts now priced into fixed income markets, McHaney sees the opportunity for capital appreciation there as somewhat limited going forward. Instead, he views that broad asset class as returning to its utility as a source of yield, duration, and ballast. In a low growth environment, though, with uncertainty about where Canadian GDP growth might come from, McHaney says that the ballast and yield provided by fixed income will be a crucial aspect of portfolio strategy.
For advisors outlining the implications of this cut with clients, McHaney emphasizes the importance of behavioural management. It’s crucial, he says, to be able to introduce the significance of this cut without playing to the hyperbole that clients may be reading in headlines.
“We knew that five per cent overnight rates were not going to last forever. Investors have done very well allocating to cash and earning that five plus percent yield on almost risk free assets,” McHaney says. “Advisors and investors have known this isn't going to last forever, and so as rates start to come back down in the very short term, what does that mean for portfolios? Do we need to tweak things around the edges?”
