The week ended on a strong note, with positive news when it comes to the potential direction of interest rates in the US. Much of the pull back we have seen over the last four weeks in equity markets in North America and abroad has been driven by several factors:

1. The expectation for when the Federal Reserve will begin cutting rates and by how much this year has been both pushed out and reduced, as we now anticipate cuts starting in September and only fifty basis points in cuts.

2. Valuations in equity markets had become unsustainably high given the change in narrative regarding interest rates. Equity markets have rallied year to date, but this was supported by the assumption a lower rate environment globally was incoming and would help to stimulate growth.

 

U.S. non-farm payrolls data released on Friday morning reflected an increase of 175,000 jobs in April, far below the market expectation of 235,000 and close to half of the jobs created in March. The reason this is good news is the Federal Reserve, as recently as Wednesday in their post-meeting press conference, have highlighted the strength of the labour market and wage growth as a reason to keep monetary policy tight. A strong labour market in an environment where inflation remains above target is not ideal, as it indicates that workers (and therefore consumers) are able to manage current price levels. With the U.S. labour market reflecting weakness, this is one of several economic indicators that the Fed looks at to support a rate cut decision. With several months to go until June and two inflation prints, as well as two jobs data reports, before the Fed meets again the potential for rate cuts sooner than expected may be possible.  Given the data to date, our expectation is for two rate cuts totaling fifty basis points (0.50%) between September and the end of the year.

 

Here at home, markets are still signaling rate cuts, with a probability of 68% that a 0.25% rate cut will arrive in June. Unfortunately, the decision the Bank of Canada makes regarding monetary policy has a direct impact on our economy – but certainly does not hold much sway over the global economy, when compared to that of the U.S. Moreover, unlike the U.S. our economy is growing at a sluggish pace with Q1 2024 GDP expected to come in at 0.62% (or annualized at an expected 2.5%). Reports from Statistics Canada this week reflected GDP growth in March was flat from February’s 0.2% increase and January 0.5% surprise jump that is attributed to Quebec teachers returning to work after being on strike. Combine this with slowing inflation and a sluggish labour market, and it is reasonable to expect the Bank of Canada to begin cutting rates in June to stimulate the economy.

 

Moving overseas, the unemployment rate remained unchanged in the Eurozone for March – coming in at 6.5%, which has been relatively where it has sat since February of 2022. These levels are still far better than those seen during the European debt crisis of 2012 that sent the unemployment rate to 12.2%. Economic conditions in the Eurozone remain mixed, but investor sentiment has begun to improve – even in the U.K. where March saw £446 million in cash inflows in to equity markets, though most of this money was invested in securities outside of the UK and focused on fixed income as the potential for rate cuts means short-term cash positions will no longer yield the return we’ve seen over the last two years. 

 

For example, here in Canada you can purchase a money market fund or even a cashable GIC that hold no risk that yield anywhere from 4-4.8% on Canadian dollar balances. When rate cuts begin it will be short-term rates that will fall to a greater degree than long-term rates – so if your objective is to maintain a passive return of 4% moving this cash into fixed-income securities that will yield the same income over a longer period is strategically ideal. Moreover, it can be more tax efficient as your passive income comes from capital gains and interest income. Capital gains are taxed preferentially, relative to interest income, even when factoring in the proposed changes to the capital gains inclusion rate in the 2024 Federal Budget.

 

Finally, in Asia foreign exchange risk has become a problem for both Japan and South Korea. The Japanese yen this week saw a further retreat in value due to the relative strength in the U.S. dollar, though Friday resulted in improvement given the probability for rate cuts in the U.S. improved. In South Korea, the same is happening to the won as it begins to show weakness as the Bank of Korea was prepared to begin cutting rates in the months ahead. Moreover, their economy is beginning to show signs of resilience which could result in an unanticipated uptick in inflation like what we have seen in the U.S.