Are We There Yet? Have Interest Rates Peaked
With weaker than expected second quarter GDP growth and the 2% inflation target in sight, the Bank of Canada kept interest rates unchanged at 5%. While we may see one additional rate increase by year end, rate cuts in 2024 should be modest if any at all. In the US, the economy has been resilient, but rate hikes are close to peak levels with inflation likely to reach the targeted 2% in 2024.
Cameron Scrivens
Portfolio Manager and President
Kai Lam
Chief Investment Officer
Canada
The Bank of Canada kept interest rates unchanged at 5% for the September rate decision and indicated a 2% inflation target is in sight. However, it is too early to talk about interest rate cuts. The freeze in rate hikes was supported by lower than expected Canadian GDP growth in the second quarter of -0.2% annualized. This was well below the 1.2% growth expected. The largest negative contributions came from inventories, net trade, and residential investment. Despite the weaker GDP figures, Canadian inflation was last reported at 3.2% in July, up from 2.8% in June, in part due to an increase in the carbon tax. In addition, we may see further pressure as oil prices have staged a material recovery in the past couple months from roughly US$70/barrel to US$87/barrel WTI. This likely contribute to the market putting a 50% probability of one more rate hike in Canada in the December meeting. Whether it is one more hike or not, we believe the effect of interest rate hikes since last year will slow the economy into a mild recession and bring inflation down to the 2% target. Canada is particularly more vulnerable to higher interest rates relative to the US as consumer debt to GDP has reached 107% in Canada, only second to Australia at 111%.
United States
The US economy has been highly resilient with a soft landing priced in the market. Second Quarter GDP came in at 2.1%. Currently Futures markets are not pricing in another hike in the US which is at a 5.5% Fed Funds rate. Labour markets remain healthy but the unemployment rate has ticked up to 3.8%. This might reflect a higher participation rate with people re-entering the job market. Whether we see a soft landing or a mild recession in the US, we expect the interest rate hikes to slow down the economy with inflation reaching the Fed's 2% target during 2024. This may open the door to interest rate cuts but will likely be modest next year.
International
In the international markets, China's economic data has been very mixed. Manufacturing, import and export data has been weak (PMI below 50) but finally showing some signs of stabilization. However, the stronger area of services (was well above 50) are now showing significant weakening of growth. The government has taken measures to support the economy. As property is the largest contributor to GDP in China, the government has been cutting interest rates, lowering property down payment requirements and encouraging banks to increase lending. Despite this, significant intervention has yet to materialize. The market expects China to grow at around 5% this year, but future growth may be more challenging to sustain.
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