- Canada saw the second month of a row of softer than expected inflation, a sharp contrast to the end of 2023.
- Recent comments from the Bank of Canada and the Federal Reserve suggest they are ready to cut interest rates later this year.
- This confirms what markets have been pricing in for some time now, but nonetheless is a welcome development.
- Markets have put up strong year to date performance even as rate cut expectations have been pushed out.
- Confirmation from central banks that they are ready to provide some interest rate relief is another potential catalyst.
Canadian inflation trending lower…
The past week saw a number of important developments for investors on the inflation and interest rate front. In Canada, inflation had spent three of the past four months disappointing investors, either rising from the month prior or coming in higher than expectations. We are happy to report that for the second month in a row, headline inflation in Canada has declined, and also came in healthily below economists’ forecast, which is what tends to be the real market mover. Markets have already priced in the economists’ forecast, and typically any reaction in the aftermath of a release is due to the deviance from expectations as opposed to the overall number.
… with “core” prices improving sharply…
More importantly for the officials at the Bank of Canada, the so-called “core” inflation measures that strip out the most volatile components have decelerated sharply. While the media often focuses on the main inflation reading, the central bank’s decisions on interest rates are guided by these readings, which they believe give a truer reading of price pressures. As seen below, these the majority of these readings are now at or through the Bank’s implied 2% target on a three-month basis, suggesting the window is opening for interest rate relief to begin shortly should these trends persist.
…setting up central banks to offer interest rate relief as early as the summer
We received confirmation that this good news is being recognized in Ottawa, as the Bank recently released a summary of their deliberations for the March 6 interest rate decision. While they are worried about cutting interest rates too soon and causing a repeat of last spring’s brief housing market frenzy, they have admitted that should the economy evolve as expected, “the conditions for rate cuts should materialize over the course of this year.” Similarly, at the Federal Open Market Committee meeting earlier this week, Fed Chair Jerome Powell said “it will likely be appropriate to begin dialing back policy restraint at some point this year.” In case you don’t speak central banker-ese, that is code for “we will likely be in a position to cut interest rates later this year.”
We expect beaten-down dividend stocks to be prime beneficiaries of a lower-rate environment
As expected, markets took this news quite well, with stocks in Canada and the U.S. rising in the aftermath of the Fed meeting, with the S&P 500 putting in yet another all-time high. Back in February, we discussed how lower interest rates should benefit dividend stocks. This messaging from the central banks is the first step to eventually lowering interest rates. Presuming current inflation trends hold and the economy evolves according to plan, markets are pricing in the first rate cut for this summer, and given that stocks are always looking forward we would expect these beaten down sectors to react ahead of an eventual move lower in rates.
The Harbour Group
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