In this week’s economic update, we are discussing two recent developments impacting the markets: shifting U.S. interest rate expectations, and geopolitical tensions increasing in the Middle East. Both of these factors are fueling investor speculation on the potential impacts on financial markets – we explore these developments and explain why we remain confident in our approach.
We are also sharing our latest video from Elvis Henrique, our in-house wealth planning specialist. In this latest video, Elvis explains how a focus on growing dividends can help minimize the impact of inflation, reduce taxes, and enable our clients to find ways to spend more on the things they want.
Lastly, we are sharing a summary of the recently released Federal Budget. We are sharing a PDF overview that highlights the most significant tax and wealth planning measures announced in the budget.
Economic Update
The past few weeks have seen more meaningful activity across global equity, fixed income, commodity, and currency markets, marked by an increase in volatility. Two developments were particularly noteworthy: the first is a significant shift in U.S. interest rate expectations due to recent inflation data. The second concerns heightened geopolitical tensions in the Middle East, following the Iranian and Israeli attacks on each other, which has left investors pondering the potential impacts on financial markets. We discuss both in this week’s update.
Geopolitical risk adding to volatility
Nearly a week ago, Iran launched an attack on Israel using hundreds of drones and missiles, reportedly in response to an Israeli strike in Syria earlier this month that killed several members of Iran’s armed forces. While Israel successfully defended itself against the attack, it represented a notable escalation in tensions as it was the first direct attack by Iran on Israeli soil. More recently, Israel has reportedly retaliated with an attempted strike that appears to be confined to military targets in Iran. Oil prices, which tend to reflect the region’s geopolitical risk most closely, have not surprisingly been volatile over the past few weeks as investors try to gauge the severity of this escalation and the risk of further destabilization in the region.
Expectations resetting after higher than anticipated inflation in the U.S.
From a market standpoint, the more influential developments have been on the inflation and interest rate fronts. The U.S. inflation data for March showed that, for a third month in a row, the pace of inflation in the U.S. was no longer easing as it had for the most of last year, and in some areas was reaccelerating. The stubbornness of inflation pressures presents a dilemma for the U.S. Federal Reserve, which had earlier expressed growing confidence that it would be able to cut rates at some point this year. But over the past week, the tone has changed, with a number of Fed officials acknowledging a need for patience before taking any action on rates. Consequently, markets expectations have also changed dramatically from anticipating up to seven interest rate cuts in the U.S. just a few months ago, to now expecting as few as one to two. This recalibration has driven bond yields higher (and bond prices lower), while stock markets have also trended downward recently, albeit relatively calmly, as investors grapple with the prospect of prolonged higher rates potentially affecting growth and corporate earnings.
Interest rate cuts could impact currencies
Meanwhile, the U.S. dollar has rallied against most other major currencies, including the Canadian dollar. There is a growing view that central banks in Canada and other regions may start cutting rates by the summer, while the U.S. may not act until later this year at the earliest. That would lead to a widening of the differences between interest rate levels across the regions, which has traditionally been a driver of currencies.
Summary
While the shift in interest rate expectations described above is not a surprise, we’re also not convinced it fundamentally alters the investment outlook. Our portfolio approach remains the same: a focus on well-managed companies with a track record of growing revenues and profits over time, with strong balance sheets, and a sound long-term strategy.
We believe that equities face a range of outcomes over the next few years that is a bit wider than normal, stemming from the rapid series of interest rates hikes over the last few years. That said, it’s clear that the U.S. economy has demonstrated less sensitivity to interest rate increases than other regions thus far, supporting its equity market. We are confident in our equity allocations and will continue to proactively look for opportunities in both equities and fixed income that meet our clients’ needs.
The Power of Growing Dividends vs. Interest
Many investors are looking for ways to minimize the impact of inflation, reduce their taxes, and find ways to spend more on the things they want. This week, Elvis Henrique (our in-house Financial Planner and wealth planning specialist) walks us through how a dividend and growth portfolio can help make these objectives possible.
To download your copy of the accompanying one-pager, click here.
2024 Federal Budget – Summary of Key Measures
Deputy Prime Minister and Minister of Finance Chrystia Freeland released the federal budget on April 16th, 2024, against the backdrop of many Canadians facing the significant challenge of elevated costs of living and continued economic uncertainty. The measures in the budget are targeted with the stated goal of building more affordable homes, making life cost less, and growing the economy.
In this summary, we are highlighting the most significant tax and wealth planning measures announced in the budget. You can get your copy of the summary here.
As always, we are available to connect with you personally. Please don’t hesitate to contact us at 519-822-2024 or elineskyschuett@rbc.com.