On Wednesday this week, the Bank of Canada announced an anticipated rate cut of 0.50%, bringing its overnight lending rate down to 3.75%. This is good news for borrowers and investors alike. This cut has already resulted in the cost of borrowing on new loans and mortgages decreasing, in addition to bringing down costs on existing variable rate mortgages. For investors holding Canadian short-term bonds, there was not an exceptional change in bond values as the cut was already priced into the market. However, expect these positions in your portfolio to appreciate in the months ahead as the Bank of Canada continues to focus on loosening their monetary policy with further rate cuts.

During his press conference following the decision, Tif Macklem started off by highlighting the fact Canada has returned to a low inflation environment. Moreover, the BoC's view is that there are balanced risks to inflation, as their concern is now focused on a soft labour market and sluggish GDP growth. To stimulate the economy and ensure conditions in our labour market do not deteriorate further, we anticipate the BoC to deliver another 0.50% rate cut in December, followed by more cuts in early 2025 that result in the overnight rate settling within the 2.5%-3% range. Any policy action typically has a lag between implementation and impact on the economy. Fortunately, we anticipate that GDP growth will remain positive next year, coming in on the sluggish side of 1.3%, but still in support of the soft-landing the Bank of Canada aims to achieve.

 

In the U.S, conditions in the U.S. fixed income market remain attractive for investors looking to both improve their long-term passive return in their portfolio and generate capital gains in the short-term. Data out of the U.S. over the last few weeks has indicated a resilient economy. This has resulted in fixed income traders re-evaluating their expectation for rate cuts from the U.S. Federal Reserve, driving up yields and decreasing bond prices. As of market close on Thursday, market expectation is for a 0.25% rate cut from the Fed in November (96.5% probability). What does this mean for you the investor? Well, if you are looking to add a reliable income stream to your portfolio long term, now is an excellent time to be evaluating your U.S. bond exposure as prices have lowered to an attractive level.

 

Though the resilience of the U.S. economy has been positive for U.S. equities, it has also resulted in a stronger US dollar which is to the detriment of markets outside the U.S. As I’ve mentioned to clients over the last several weeks and in my weekly notes, mid-cap equities and emerging markets are positioned to deliver meaningful returns in the medium term. However, their performance is directly correlated to the direction of interest rates and the strength of the US dollar.

 

With the market pricing in a slower pace of rate cuts by the U.S. Federal Reserve, the case for adding to or entering positions in mid-cap equities versus maintaining a current position in large-cap equities is hard to make. This is exemplified when you look at the performance of their respective index performance in 2024. The S&P 500 Index has returned 21.80% YTD and 7.05% in the last three months while the S&P Mid-Cap 400 has returned 12.45% and 4.31% in the last 3-months. However, the gap in performance is directly related to a higher rate environment as mid-cap companies carry significantly more debt than their large- and giant-cap peers, which has resulted in comparatively weaker net revenue and valuations. This should improve as rates decline, and debt servicing expenses reduce, which should translate to improved net revenues and improved valuations – which are also contingent on the U.S. economy sticking the soft-landing.

 

In Emerging Markets (EM), outside of the impact of higher interest rates, the US dollar also significantly impacts the performance in EM equity markets. Historically, as the US dollar has declined in value Emerging Markets equities have seen valuations improve. As you can see in the chart below the US dollar has weakened in the last several years post-pandemic, which has resulted in emerging market equity performance improving. Even over the last several months as market expectations for rate cuts by the Fed were lowering the US dollar, you can see a considerable lift in EM equities – however over the last several weeks this gain has eroded as expectations for a slower pace of cuts and more resilient US dollar have taken hold.