‘I thought they’d nuke the market …. but this is shockingly the right call now’

How a smaller than expected interest rate increase brings opportunities for advisors

‘I thought they’d nuke the market …. but this is shockingly the right call now’

The Bank of Canada surprised advisors yesterday by only increasing its interest rate by 0.5% rather than 0.75%, heralding a new era of caution despite this being the sixth consecutive increase with the promise of more as it still aims to achieve its 2% inflation target.

“It looks like they’ve decided to take a more cautionary route and opt for a smaller than expected rate increase. They’re just as concerned about the impact on consumers with interest payments moving higher as the impact on the economy as things are slowing down,” Zach Davidson, a wealth advisor and portfolio manager with National Bank Financial Wealth Management, told Wealth Professional. “That was definitely unexpected as far as what the market was looking at, but the rates have moved higher, into more restrictive territory.”

Read More: Another hefty rate hike looms amid recession warnings

Yesterday’s increase brought the bank’s overnight rate to 3.75% with the bank rate at 4% and deposit rate at 3.75%.

The bank also said that, even though the consumer price index (CPI) inflation had declined from 8.1% to 6.9%, it expects it to ease further as higher interest rates help to rebalance demand and supply, price pressures from global supply disruptions fade, and the past effect of higher commodity prices dissipate. It also projected that global growth would slow from 3% in 2022 to 1.5% in 2023, and pick up to 2.5% in 2024. It noted that housing activity has sharply retreated, and business and household spending has softened, so economic growth is also expected to stall until mid-2024.

Read More: Bank of Canada surprises markets with latest interest-rate hike

“They’re starting to slowly shift and maybe take a little more measured approach to see what the impact is,” said Davidson, noting that economic growth is starting to cool around the world. 

Davidson noted the market wants to see a more data-dependent stance, so the bank doesn’t push the rates too far. Bond yields have been moving higher and the U.S. dollar has appreciated, also impacting inflation.

“This opens a door for a bit of a pivot and downshifting a little to see what the impact of the rate increases is on what occurred this year,” he said.

In the meantime, he is reminding his investors to take a longer-term approach, especially now that bond yields and dividend yields are higher while growth stocks are down, and valuations have declined dramatically. “There are more investment opportunities for those who have a medium to longer term investment timing horizon,” he said, noting that stocks are still a good inflation hedge, particularly for companies that are still able to grow their business and their dividends. And have strong management teams and high insider ownership.

“We’re going through one of those pessimistic periods that were set up for positive surprises and you just want to stay focused and stick with an asset allocation that you’re comfortable with and not respond to what’s happened, but position for what the future holds as well.”

Chad Larson, a senior portfolio manager, senior investment advisor, and founder of the MLD Wealth Management with Canaccord Genuity Corp., said he was initially disappointed that the Bank of Canada didn’t do the 75 basis point increase. But, he then considered the unprecedented amount of pandemic stimulus that it was trying to counter. That’s already impacting housing and could soon impact employment, too, even though the bank flagged that it would continue to increase rates and not yet become less hawkish.

“I originally thought that they would raise the rates by 75 basis points, even 100, and nuke the market – create the kind of job loss nuclear winter that melts inflation,” he said. “The problem is if they don’t let this tighter monetary policy linger for long enough, and they start cutting, all they’ve done is throw a wet blanket on inflation. So, the Bank of Canada’s decision to do a smaller than inspected increase just reconfirmed to the market that more will need to happen. So, I think this is shockingly the right call now and I think the message is more pain for longer.”

Larson recommended that advisors remind their clients that “recession is not a four-letter word. It’s part of the economic cycle, and, technically, is only two quarters of consecutive negative growth.

While he said that the 60/40 traditional portfolio model is broken, it’s time to ensure that portfolios are still well positioned because “there is more opportunity to make money coming in and coming out of a recession than there ever is coming in and coming out of a market top or market bubble.”

While there have been massive pullbacks in equity valuations, he’s now seeing some cracks in corporate earnings, but “it’s still bargain hunting season”. So, he’s looking to actively deploy through the bottom trough of an economic cycle and, over the next six to 18 months, taking advantage of the opportunity to buy equities at a cyclical low. 

Despite the recent violent rallies, which can happen more often in a recession, Larson said: "An active advisor, anchored by discipline and process, is going to come out of this with a larger share of wallet and accelerated returns.”

Chad Larson’s comments are solely his and not those of Canaccord Genuity Corp.