Interest Rate Cuts Floating Further Downstream
April 10, 2024
April 10, 2024
This morning, the Bank of Canada (BoC) announced their decision on the overnight rate, affecting interest rates, mortgages, lines of credit rates and investment portfolios. As widely expected, the BoC left the overnight rate unchanged at 5% for the sixth consecutive meeting. Consumers waiting for lower mortgage rates, corporations wanting to refinance their debt at lower rates, and fixed income portfolio managers waiting for bond prices to rise will all have to wait a little longer.
The market’s assessment of the Bank of Canada’s policy statement is mixed. Some viewed the statement as strong enough to remove the possibility of a June rate cut, while others viewed the statement as neutral enough to keep a June rate cut on the table.
“We are seeing what we need to see, but we need to see it for longer to be confident that progress toward price stability will be sustained,” Mr. Macklem said.
Inflation is what the BoC has been battling, and they’ve made considerable progress. Price pressures have retreated from the heights of 5.5% down to approximately 2.8%. The challenge for the BoC is that inflation has settled in around the 3% mark and further progress has been slow.
“The further decline we’ve seen in core inflation is very recent. We need to be assured this is not just a temporary dip,” Mr. Macklem continued.
The challenge they now face is if they cut too soon, they risk re-igniting inflation, erasing the progress they have made. Conversely, if they wait too long to cut, the economy may decelerate more than they would like.
“We don’t want to leave monetary policy this restrictive longer than we need to. But if we lower our policy interest rate too early or cut too fast, we could jeopardize the progress we’ve made bringing inflation down,” Mr. Macklem said.
It’s important to understand that interest rate adjustments don’t impact the economy overnight. These changes take anywhere from 6 to 12 months to filter their way into the economy. This leaves the BoC in a tough position. If they’re going to execute interest rates adjustments properly, they need to anticipate economic data at least 6 months into the future. The problem is they don’t feel comfortable enough to put action into place until inflation data reinforces that it won’t become a problem again.
Meanwhile, the U.S. Federal Reserve faces a similar challenge. This morning, the U.S. inflation report for March was released and the numbers were a little hotter than expected. This inflation print seems to have slammed the door shut on the possibility of a June rate cut from the U.S. central bank, pushing their rate cuts later into 2024.
All things considered, interest rates along the yield curve have moved higher by approximately 0.10% this morning and 0.53% year to date.
Bottomline: Portfolio management is not for the faint of heart. Imagine throwing a ball in a fast-moving river and watching a golden retriever swim after it. The nature of any retriever breed is that they have incredible instincts when anticipating where an object is going, helping them chase it down as efficiently as possible. If the ball is floating downstream in the middle of the river, immediately the dog begins swimming on a diagonal line from shore, not towards the ball, but in the direction the ball is floating. Remarkably, they meet the ball in the middle of the river without wasting energy swimming towards where the ball began floating. It might seem obvious and simple, but it’s in their bloodline.
When it comes to portfolio management, a similar approach is critical. While the Bank of Canada is compelled to wait for inflation data to soften further before reducing the overnight rate, we’re compelled to position Matco’s Fixed Income Fund in advance. We’ve extended the term and duration of our bond holdings, which will allow for greater capital appreciation when rates move lower. We’ve taken advantage of current higher interest rates by investing in newly issue corporate bonds at very attractive yields. With positioning in place, patience will be required.
Last year wasn’t much different. Interest rates rose through the first three quarters of the year, creating a difficult environment for fixed income portfolio managers. Those who stuck with a patient and steady approach were rewarded in the fourth quarter when interest rates moved dramatically lower. Matco’s Fixed Income Fund returned 6.0% in 2023, most of which was the biproduct of the interest rate rally through the month of December. We’re only three months into 2024, but this year seems to be shaping up similarly. Bond prices have been under pressure thus far, but patient portfolio management is likely to be rewarded in the latter half of the year.
Source: Bloomberg, Matco Financial Inc. as at April 10, 2024.
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