Dear Friends,

Happy New Year! I hope your Christmas and holidays were great.

My Miami Dolphins were finally put out of their misery on Saturday night after being ousted from the NFL playoffs by the defending Super Bowl Champion Kansas City Chiefs. Riddled with arguably more significant injuries than any other NFL team, this is something difficult to overcome. That, and having to deal with the fourth coldest kick-off in NFL history at -4 (-27 with the windchill). Tough for a warm weather team… but no excuses here.

Now this pains me to say…. but congratulations to the Buffalo Bills for winning the Division and securing some home field opportunity these playoffs. After having their game rescheduled because of inclement weather, they will kick off today at 4:30 against the Pittsburgh Steelers. Desperately searching for a bit of consolation, I’ll be siding with a few good friends today who are die-hard Steelers fans. I’m still uncertain if the Bills actually found enough people to shovel their stadium…. we shall see.

Market action in the first few weeks has been relatively muted, contrasting with the strong gains witnessed towards the end of last year. This moderation can be attributed to a string of slightly stronger global economic data, prompting investors to reassess their expectations for interest rate cuts. We expect the timing and degree of rate cuts to be one of the biggest debates this year. We address this more below.

The Federal Reserve, the central bank in the U.S., decided to hold interest rates steady at its most recent meeting in December. During its post-meeting press conference, Chairman Jerome Powell suggested that the Fed has been faced with three big questions over the past few years: how fast to raise rates, how high to raise them, and the timing and size of cuts. While the first two questions were its predominant focus until recently, the question of rate cuts is now coming into view. The Fed’s December meeting revealed that, on average, policy makers expect to cut interest rates by nearly 0.75% in 2024 and expect the pace of inflation to slow to 2.4% (from over 3.0% today) and the unemployment rate to rise modestly, to 4.1% (from 3.7%).

Unlike the Federal Reserve, the Bank of Canada does not provide explicit future rate projections. But investors expect Canada’s central bank to similarly pivot towards interest rate cuts. The market is pricing in close to 1.4% in rate cuts by both the Bank of Canada and the Federal Reserve this year, with the latter expected to cut as early as March and the former as early as April. Despite the market’s expectations, there are reasons to believe that the Bank of Canada may act sooner and more swiftly than its U.S. counterpart, given its earlier start to rate hikes and Canada’s heightened sensitivity to interest rates due to higher household debt and shorter mortgage terms. Moreover, the Canadian economy has shown early signs of strain from the impact of higher rates with more sluggish GDP growth, weaker consumer spending, and dwindling job gains.

The two factors that should ultimately determine the timing and degree of interest rate cuts are inflation and employment trends. Last year saw a steady decline in the pace of inflation in both Canada and the United States, but some pressures remain. One example is the cost of shelter, which makes up the largest weight within the Consumer Price Index in both countries. It includes categories such as rent and mortgage interest costs, both of which have shown few signs of abating, particularly in Canada. Furthermore, the downward trajectory of inflation has started to flatten after a relatively sharp decline through the first half of the past year. December’s U.S. inflation data, released this past week, even showed a modest uptick. We believe that policymakers at the Bank of Canada and the U.S. Federal Reserve will aim to get inflation sustainably under 3.0% before considering any rate cuts.

The Federal Reserve is also focused on employment as part of its dual mandate. While there has been a moderation in job growth, it is hard to argue that the employment backdrop in the U.S. requires any support from the central bank. In our view, a more meaningful deterioration in the U.S. job market may be required before the Fed considers any move to reduce rates.

Investors will remain hyper-focused on inflation and employment trends this year, as they try to gage when central banks may take action and cut interest rates. We foresee this fueling swings in the markets in both directions as investors recalibrate their expectations. Nevertheless, this year should mark a notable shift in the environment as central banks transition to a more accommodative policy. That has historically proven to be a more constructive backdrop for investors. We plan to shift our attention to the earnings season and the escalating conflict in the Middle East over the weeks to come.

Should you have any questions, please don’t hesitate to reach out.

Have a great week.

Best Regards,

Frank