Concerns are set to shift from trade uncertainty to a growth slowdown in 2019, with the Bank of Canada putting interest rate hikes on hold for the first half of the year.
That’s the view of Aubrey Basdeo, BlackRock’s head of Canadian fixed income, who told WP that his outlook for the country revolved around three main themes – growth slowdown, the neutral interest rate, and investors balancing risk and reward.
He said the flipside to a slowdown is that recession risk will grow, something that is contributing to market volatility. He added that worries about low domestic oil prices, tighter financial conditions on high household indebtedness, fading US fiscal stimulus and heightened US-China tensions will likely hold back economic activity in Canada in the coming quarters.
Basdeo said: “We think that the focus is going to shift more to growth slowdown concerns, which will have a bigger impact on the markets during the initial part of the year.
“It will take some time to assess what the trajectory for growth is going to be for the rest of 2019. In part, that was what the Bank of Canada was trying to address in its December statement. It made the seminal comment that there may be additional room for non-inflationary growth – and I think it may point to essentially two things they were trying to highlight.”
Firstly, the impact of CapEx and the follow-through of that investment has the potential to boost the supply side of the economy, creating potentially additional room for non-inflationary growth.
Basdeo believes that will buy the bank some time before they decide to raise rates again, which ties into his second theme of central banks steering the rate back to neutral.
He said: “If you see that down shift from between 1990 and 2008 or so – it was around 4% as the neutral rate. We’re at 1.75% close to the bottom end of that range [but] to the extent that you’re almost there.”
He added the Bank has got the ability to analyze if inflation is not picking up in any rapid way, giving them time to calibrate where they need to go without rushing.
The oil price drop will cause Governor Stephen Poloz to be more patient, said Basdeo, who also questioned the Bank’s interpretation of a tight labour market.
He said: “We are not seeing wage pressure pick up. So you go to the last number and 94,000 [new jobs], most of which are full-time. The average wage growth grew sub 2% so that’s not consistent with a tight labour market and strong growth, so something is happening in the labour market that is different this time around.
“That suggests to me that the Bank of Canada needs to better understand the dynamic better before it starts to get ahead of itself in terms of removing accommodation.”
For investors, the theme is about balancing that risk and reward while ensuring your portfolio has built-in resilience. Basdeo said you are better compensated for owning the front end of the curve relative to the back end and in particular government bonds as opposed to adding credit to the profile.
He said: “That’s one part of our portfolio construction theme. The other is you should think about some barbelling on the fixed income side because there is a risk the growth story could get derailed if you have a full blown trade war between China and the US, for example.”
He added: "Part of the consideration is adding a balance to the portfolio by adding some long-duration exposure to your portfolio. That’s how you protect yourself if you get into a much more growth slowdown story.”
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