Dominique Lapointe expects another BoC hike in December and says the Fed will likely resume hiking soon
For Dominique Lapointe, Senior Director of Macro Strategy at Manulife Wealth & Asset Management, the Bank of Canada’s decision to hike its key interest rate for the first time since 2023 was a necessary outcome of new inflation forecasts. Over the past two months, Canadian inflation came in slightly elevated largely due to oil prices. Earlier in October, however, Bank of Canada (BoC) Governor Tiff Macklem attended an IMF meeting in Bangkok where he warned that persistent inflation driven by higher global oil prices would cause a revision of the BoC’s inflation outlook. That new outlook, Lapointe says, mandated an interest rate hike and will likely prompt a further hike in December unless oil prices come down or Canadian unemployment skyrockets.
Lapointe explained that Canada is not alone in its rate hiking cycle, despite the decision by the US Federal Reserve yesterday to leave its interest rates unchanged after hiking in September. While the US and Canada are starting from different places and may hike at different cadences, Lapointe sees an ongoing hiking cycle tied to supply-side inflation. Despite the pressures that may place on consumers and both the US and Canadian economies, Lapointe highlighted why asset owners may not need to panic.
“With that forecast that the [BoC] put in today. And the very tight relationship that they seem to be putting between oil prices and their decision-making process, it's going to be hard not to raise interest rates if oil prices don't come down in the near term,” Lapointe says. “So then when we go in Friday, we're going to have a GDP print. We're going to have another inflation print in 3 weeks, jobs reports. To me, awkwardly, they're going to matter less because they're all backward looking. And it seems that the Bank of Canada is very concerned about the future… For me, it's really about oil at this point.”
Why hikes now seem inevitable
Lapointe emphasized the BoC’s business outlook survey to show that as of now most businesses are only passing on about 20 per cent of the cost increases they’ve incurred from the conflict. They expect to soon pass on 44 per cent of those costs, which ought to accelerate inflation. Lapointe sees a resumption in prewar oil flows through the Strait of Hormuz as highly unlikely and so long as the conflict remains a feature of geopolitics he argues that inflation will remain elevated.
The Fed has been driven by similar inflation pressures, Lapointe notes, though their higher rates as a starting point and September hike gave Fed Chair Kevin Warsh enough cover to hold interest rates steady for this month. An unexpected slight rise in unemployment gave the central bank further cover to hold, but Lapointe is convinced that the Fed will hike again in December and will likely hike in March. He says that the BoC will likely hold in January after the December hike he predicts for them, because auto tariffs will take further hold in January if there is no resolution to US-Canadian trade disputes. He says the BoC will then move upward alongside the Fed in March.
Risks and opportunities for investors
Despite some volatility in the bond market, Lapointe argues that the higher yields a client can get in a balanced bond fund should make the asset class interesting. Even if we’re in a hiking cycle that could put further pressure on bond prices, solid yields and strong diversification might be enough to smooth out returns.
Looking at Canadian equities, Lapointe sees plenty of reason for positivity. Despite, or in fact because of, a lack of tech exposure on the TSX that equity market offers some attractive qualities to investors. Energy is, of course, in high demand but so are other commodities and mining stocks. The banks have a high degree of beta in performance to financial markets and can often do well as rates rise and increase net interest margins. Canadian financials’ exposure to under pressure aspects of the economy like the housing market should be considered, but Lapointe argues that the exposure is not as large as it once was.
Considering US markets, Lapointe says the outlook comes down more to a view on AI than a direct impact of higher capital costs. Despite large debt issuances on the part of AI ‘hyperscalers’ he argues that the existential nature of the AI competitive race means these companies are not very sensitive to interest rates in their spending strategy. AI now represents a significant portion of the S&P 500 across a number of sectors beyond technology, and an investor with a bullish view on the technology may see that as a positive. An AI skeptic may see that as a risk. US equity P/E multiples have compressed which might make the market look a bit cheaper from a valuations standpoint, while earnings continue to be strong. Lapointe cautions against a heavy weighting to tech at this point in the cycle and says that a slightly more cautious underweight to the US with a more positive view on Europe and Canada might be prudent.
While interest rate increases are rarely greeted as good news, Lapointe emphasizes that they shouldn’t be treated as bad news either. Instead, he emphasizes what these policy decisions tell us about how central banks view the economies they help govern.
“The fact that central banks are raising interest rates in general is because the economy is in a good space in general. Now we can say, well, this time is not good because, it's about a supply-side shock from oil. But they're doing it nonetheless. If unemployment was trending up in a significant way in the US and Canada and we see real issues like people selling their houses at a big discount, I’m confident that central banks would not raise interest rates,” Lapointe says. “The fact that they're doing so and trying to front-run upcoming inflation means they're confident about the fundamentals. And I think that's the message investors should tell their clients.”
