But don't expect central bank to surpass 1.75% because of high accumulated debt load
With only days left until an anticipated Bank of Canada rate hike, and Statistics Canada reporting that inflation has reached a 30-year high, Invesco expects six rate hikes this year, but anticipates they won’t climb any higher because of the cost of servicing the accumulated debt.
“It looks increasingly likely that the Bank of Canada is going to begin its rate hiking cycle on January 26,” Avi Hooper, Invesco’s Fixed Income Senior Portfolio Manager, told Wealth Professional. Given that the central bank had been messaging that a hike was coming, he said, “markets were already pricing in these rate hikes in the fourth quarter of last year. So, the markets were getting ahead of themselves, and the central banks have caught up to them.”
The Canadian economy has recovered more quickly, and is in a stronger position, than anticipated. So, Invesco expects there will still be a lot of stimulus, particularly from the government for the pandemic, in the first half of the year.
“We think growth trends are going to remain reasonably buoyant and inflation is also going to remain a little more elevated in the first half of this year,” he said.
Hooper then expects the central banks to tighten their monetary policy, and become less stimulative, in the second half of the year to shrink their balance sheets and soften growth expectations.
Still, Invesco is expecting the Bank of Canada to make six rate hikes this year, and is concerned that we “could see a bigger market reaction” if they don’t, since it’s already priced in all of those in.
However, Hooper said the current situation has reduced market volatility and increased certainty and investment, which is good backdrop for financial assets.
“When you’re at the turn, which the banks clearly are and are embarking on rate hikes, even though the market has already priced in,” he said, “you start to witness, more broadly speaking, market volatility because you’re just moving from this forward guidance.”
Invesco is looking at the attractive valuations in Canadian fixed income and 30-year maturities for bond yields which will attract some investors. “Asset liability-focused investments start to reach a level where that makes a lot of sense,” he added.
Hooper isn’t anticipating that the six interest rate hikes will amount to more than 1.75%, which was the late 2018-2019 peak before the rates were reduced for the pandemic, because of the accumulated debt stock across all economic sectors – government, corporate, and household. Current interest rates have dropped the debt-servicing costs, so he doesn’t expect that to increase too much because it would make the service costs on that much debt far too high.
“In our view,” he said, “the amount of debt outstanding across all parts of the economy is what will ultimately limit the ability for interest rates to rise meaningfully.”