By: Jeff Pollock
July 7, 2017
This morning’s strong Canadian jobs report makes it all but certain that the Bank of Canada will hike rates next Wednesday. We added 45,300 new jobs last month, which exceeded economist expectations for a mere addition of 10,000 new positions during June. Should our central bank hike rates on July 12, this will be the first increase in almost seven years.
Officially, the Bank of Canada’s broadly written mandate requires it to:
Regulate credit and currency in the best interests of the economic life of the nation, to control and protect the external value of the national monetary unit and to mitigate by its influence fluctuations in the general level of production, trade, prices and employment, so far as may be possible within the scope of monetary action, and generally to promote the economic and financial welfare of Canada.
Historically, however, the central bank’s objective has been to manage the country’s inflation. Eying that metric in isolation, there’s no pressing need to hawkishly increase rates right away. When asked about our weak domestic inflation, Bank of Canada Governor Stephen Poloz said, “if we only watched inflation and reacted to inflation, we would never reach our inflation target [of 2%]. We’d always be two years behind in the reaction.”
Notwithstanding the poor inflation data, higher rates are likely on their way due to a strengthening economy. In Q1 of this year, our real GDP grew at a 3.7% annualized rate. Despite the weakness in the resources sector, Canada is no longer a goods-producing country like it once was many years ago. Instead, over 70% of our economic output stems from the services sector.
As the Bank of Canada hikes rates, the Canadian banks will follow. In anticipation of higher rates, the 5-year Canada bond yield – which banks use as a benchmark to price their mortgage rates – has jumped from 0.93% to 1.48% in just over a month. Variable rate borrowers, which command about a 25% share of the Canadian mortgage market, will feel the impact immediately, but a 0.25% rate hike will likely prove to be immaterial for the economy at large.
Anticipating higher rates eventually, our Investment Committee has had no exposure to corporate bonds and remain well exposed to financial institutions that benefit from higher rates. It’s worked out well for our clients’ performance, who have been happy with their portfolio results. While we expect a rate hike next week, we do not believe the Bank of Canada will embark on a series of rapid rate increases to offset economic growth. Instead, rate increases will be slow and gradual going forward. The stocks we presently own for clients will perform well in this environment.
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