Canadians should expect inflation to remain high—and more rate hikes

As widely expected, the US Federal Reserve (the Fed) raised the target rate by 25 basis points (bps) to 5.25%. Today’s rate increase leaves the ceiling on the Federal funds target range at 5.50%. It may also suggest further monetary policy tightening in the form of additional rate hikes could be coming our way throughout the second half of the year.

Does this interest rate hike impact Canadian investors?

One of the biggest concerns is if interest rates linger at elevated levels because inflation continues to stay above the 2% target rate.

Aaron Young, Vice President, Fixed Income at CIBC Asset Management says “we're keeping a cautious outlook on the economy and signs of an economic slowdown are emerging. As the effects of rising interest rates and high inflation filter through the economy, potential risks to asset quality and credit losses cannot be ignored.”

Trevor Bateman, Head of Credit Research at CIBC Asset Management says “in credit markets, the impact of high interest rates and tighter lending conditions is surprisingly impalpable. While borrowing and refinancing costs have soared, we have yet to see a meaningful slowdown in revenue and cash flow growth. Low-quality companies are particularly interesting because they may face obstacles in meeting refinancing and liquidity needs. Deep-dive fundamental analysis alongside thoughtful stress testing plays a more critical role than ever in our credit research.”

How do US interest rate increases impact the Canadian economy?

Craig Jerusalim, Senior Portfolio Manager, Equities, at CIBC Asset Management, says although the rate hike was highly anticipated, the degree of hawkish commentary accompanying the hike was more nuanced. “It appears as if Fed Chair Jerome Powell is not willing to allow complacency to creep back into the consumer psyche.” In his statement following the rate announcement, Powell (at the very least) sounds like he’s willing to keep raising interest rates by remaining data-dependent.

Mr. Jerusalim confirms “the dilemma Powell now needs to manage is stubbornly high inflation and tight labour conditions versus slowing economic activity. This balancing act only gets harder from here as the lagged impact of the prior ten rate hikes only now begins to bite.”

As we keep a close eye on both the Fed and the Bank of Canada, the risk of policy mistakes from this point forward also begins to rise precipitously. US equities have been willing to look past tighter financial conditions thus far. However relative to global and Canadian equities, they are looking quite over extended.

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