Ahead of our normal monthly newsletter we wanted to comment on a volatile week for markets amid interest rate and inflation uncertainty.
Global markets have been under notable pressure in recent days. The trigger was a recent inflation report that has investors believing central banks will have to tighten financial conditions more than planned, thereby increasing the odds of a future recession. We share our perspectives below.
The most recent U.S. inflation reading for the month of May came in at 8.6%, representing the highest inflation rate in over 40 years. It indicates pricing pressures are not only elevated, but still rising. That stands in contrast to what some investors were hoping for: signs that inflation may have already peaked and was on the verge of easing. Core inflation, which excludes food and energy, did show some moderation, but it too was higher than expected. Moreover, the inflationary pressures that began well over a year ago in areas like vehicles and household goods have broadened to other categories such as public transportation and rent. Some of these areas have historically proven to be more persistent and slow to normalize, suggesting pricing pressures are at risk of being uncomfortably high even after inflation peaks and begins to moderate, which remains a possibility for the second half of the year.
Following the inflation release, bond yields rose meaningfully and markets now believe the U.S. Federal Reserve’s “Federal Funds Rate” will reach 3.4% at year-end, versus the 2.4% it was expecting just a few months ago. It’s not necessarily that much different in Canada. In other words, markets expect central banks to raise rates even more forcefully than what they have telegraphed thus far.
The predominant concern is higher rates will lead to tight financial conditions. This is often characterized by a material change in the availability and access to credit that causes consumers and businesses to re-evaluate their spending, hiring, and capital expenditure plans. Historically, these kinds of conditions have resulted in recessions. Not surprisingly, recessions, or even the anticipation of them, have driven some of the weaker periods of stock market performance. On the other hand, some of the strongest periods of market performance have traditionally begun amidst periods of economic hardship, as markets begin to anticipate the potential for an economic and earnings recovery well ahead of one actually occurring.
The odds of a recession over the next few years have undoubtedly risen, and may continue to increase through the second half of the year given the tightening of financial conditions. There are early signs of a slowing in some of the more interest rate sensitive sectors of the North American economy, such as housing for example. In some ways, this comes as a relief to many who have been concerned, particularly in Canada, about the seemingly endless rise of house prices and the significant decline in affordability.
A slowing in the domestic housing market, should it occur, may ironically be a positive development and a sign that policy makers are effectively reining in pricing pressures in some parts of the economy.
We have been preparing our portfolios for a wide range of economic outcomes by undertaking regular portfolio reviews, re-evaluating positions across all asset classes, and considering rebalancing to the targets in our investment plans. Moreover, episodes of volatility like this are typically characterized by indiscriminate amount of selling across all assets, regardless of quality. This can present investors with opportunities to add to existing holdings or build new ones. These are some of the actions we continue to explore in our portfolios.
Should you have any questions, please feel free to reach out.
If you have questions about your portfolio or financial plan and want to book a review with one of our advisors, please call Corinne at 613-721-8928.
Mark, Sarah, Peter, Corinne & Nathalie
Gallivan Wealth Management Team
RBC Dominion Securities Inc.* and Royal Bank of Canada are separate corporate entities which are affiliated. *Member-Canadian Investor Protection Fund. RBC Dominion Securities Inc. is a member company of RBC Wealth Management, a business segment of Royal Bank of Canada. ® / ™ Trademark(s) of Royal Bank of Canada. Used under licence. © 2022 RBC Dominion Securities Inc. All rights reserved.
This information is not investment advice and should be used only in conjunction with a discussion with your RBC Dominion Securities Inc. Investment Advisor. This will ensure that your own circumstances have been considered properly and that action is taken on the latest available information. The strategies and advice in this report are provided for general guidance. Readers should consult their own Investment Advisor when planning to implement a strategy. Interest rates, market conditions, special offers, tax rulings, and other investment factors are subject to change. The information contained herein has been obtained from sources believed to be reliable at the time obtained but neither RBC Dominion Securities Inc. nor its employees, agents, or information suppliers can guarantee its accuracy or completeness. This report is not and under no circumstances is to be construed as an offer to sell or the solicitation of an offer to buy any securities. This report is furnished on the basis and understanding that neither RBC Dominion Securities Inc. nor its employees, agents, or information suppliers is to be under any responsibility or liability whatsoever in respect thereof. The inventories of RBC Dominion Securities Inc. may from time to time include securities mentioned herein. RBC Dominion Securities Inc.* and Royal Bank of Canada are separate corporate entities which are affiliated. *Member-Canadian Investor Protection Fund. RBC Dominion Securities Inc. is a member company of RBC Wealth Management, a business segment of Royal Bank of Canada. ® / ™ Trademark(s) of Royal Bank of Canada. Used under licence. © 2022 RBC Dominion Securities Inc. All rights reserved.