Will hawkish central banks invite even more volatility?

Slow economic growth could create a 50/50 chance of recession next year, according to Mackenzie Investments CIO

Will hawkish central banks invite even more volatility?

When Mackenzie Investments released its 2002 Mid-Year Outlook just ahead of the Federal Reserve’s rate hike of 75 basis points yesterday, it was already pointing to the hawkish nature of the central banks.

“The most significant piece of the market puzzle this year has been the rapid change in hawkishness by developed markets’ central banks, which has been led by the Federal Reserve as well as the Bank of Canada,” Steve Locke, Mackenzie’s chief investment officer, told Wealth Professional.

“We can’t understate the effect that’s had on yield curves, equity markets, and certain factors within the equity markets. As we look ahead, there’s going to be some volatility because we expect central banks to continue on the hawkish path that they’ve set for markets from earlier this year. So, we expect more rate hikes from the Bank of Canada and from the Federal Reserve.”

The good news is those rate hikes have already been priced into the market, particularly the yield curve, but Locke expects there may be more volatility in the equity markets and some credit market areas, such as high-yield bonds.

But he expects the Fed’s tightening will begin to pull down economic growth in the second half of this year and there’s a 50/50 chance that it could create a recession in 2023. Mackenzie is watching that space between inflation and slowing growth, wondering what the inflation rate could become.

Locke sees some opportunity building, given the central banks delivered and projected rate hikes.

“There are some yields available in some areas of high quality, fixed income, and particularly investment grade corporate bonds that are starting to look very attractive,” he said.

Central bank policy was one of three factors Mackenzie’s 2022 Mid-Year Outlook flagged as significant trends that shaped Canadian and global markets this year and are expected to continue to do so for the rest of the year.

With Russia’s war in Ukraine disrupting commodity markets and COVID-19 continuing to impact supply chains, growth was slower, and inflation higher, than expected  this year as central banks began to hike interest rates to fight inflation.

Inflation has also been hard on growth-oriented markets, but Mackenzie expects rising commodity prices could provide a boost for producer-oriented countries, such as Canada, and support relative outperformance in Canadian equities.

That augments other bright spots Locke saw on entering 2022 with North America’s strong economy, low unemployment levels, significant labour demand growth, and many industries recovering well. So, it’s done well, relative to other regions, even with the central bank tightening.

“Canada’s orientation toward commodities relative to the U.S. had us positioning in favor of Canada in our original recommendations at the beginning of year as well as our update in June,” said Locke.      

As for its third theme, Mackenzie expected that China would see renewed growth in 2022, but its ‘dynamic zero COVID policy’ has resulted in more lockdown and is straining global supply chains.

While China remains committed to supporting a 5.5% growth target with its monetary and fiscal policies, Locke noted that it tightened financial and regulatory conditions around its real estate market and saw its economy tighten in the second half of 2021, which impacted 2022, too.

“Those two things combined have really contributed to slower growth than expected in China,” said Locke. “We’ve seen the central bank in China reacting by easing policy, which contrasts with the central banks of North America and Europe, which have been tightening policy.

Mackenzie anticipated that China’s COVID policies will continue to pose a challenging economic risk, even though there’s been some easing in certain cities and Chinese authorities now seem to realize they need to balance economic growth with prevention of the spread of COVID. Mackenzie expected China’s caution to continue, and its GDP growth to bottom this year.

“We’re not out of the woods yet,” he said, “but we can see a little bit of the edge of the forest.”