Financial Panorama

The return shown is the total return which includes the reinvestment of income and capital gains distributions.
Source: Morningstar Direct.

Results – Canadian bonds

The FTSE Canada Universe Bond Index, which includes Canadian government and corporate bonds, has posted a positive return of 3.21% year to date (at October 31, 2024).
(Source: Morningstar Direct)

Our analysis of events

Inflation continues to decline, as does the job market

• On November 7, the U.S. Federal Reserve (Fed) cut its key interest rate by 0.25%. The discount rate fell from 5.00% to 4.75%, and the market is anticipating the possibility of another cut in 2024.
• For its part, the Bank of Canada (BoC) lowered its policy rate by 50% on October 23. Although its mandate is essentially focused on controlling inflation, the Canadian central bank also wants to support and develop the job market, like the Fed. On both sides of the border, employment has thus become the most important variable, with inflation now seemingly under control. The market is expecting the BoC to announce another rate cut in December, but the extent of the cut (0.25% or 0.50%) is still uncertain.
• The U.S. economy remains robust, reducing the urgency of rate cuts. The main effect of the divergence between Canadian (more rate cuts) and U.S. (fewer rate cuts) monetary policies will be a reduction in the value of the Canadian dollar. In addition, hostilities in the Middle East and an upturn in the Chinese economy could lead to an increase in the price of oil, which would limit the weakness of the loonie.
• The variables with the greatest impact on the markets continue to be the rate of inflation and how quickly it falls. However, the employment situation and the frequency of rate cuts are now just as important, if not more so.
• In Canada, the annual inflation rate was 1.6% for September, down from the previous month (2.0%) and moving in the right direction. In the United States, the annual inflation rate eased to 2.4% in September, down from the previous month.
• The new Trump administration’s protectionist political agenda and its implementation will be among the most important variables in 2025.

How markets can influence political decisions

The bond market and political power have a close and complex relationship. Government decisions taken by the party in power must often bow to the demands of the market, at the risk of investor discontent. A few examples:

• In the case of the new Trump administration, fiscal policies that would increase U.S. deficits and debt could trigger a Liz Truss event, named after the British Prime Minister who succeeded Boris Johnson in the post in 2022. In that particular situation, the Prime Minister’s desire to cut taxes and increase deficits at the same time was perceived by the bond markets as irresponsible. This disapproval was reflected in a sharp rise in the yields demanded by investors and a significant loss in value of British pension plan assets. This strong signal from the markets, clearly indicating that the cost of financing the public debt would be much more expensive, quickly forced the government to do an about-face.
• During the Clinton presidency in the 1990s, the fear of high deficits resulted in a rapid rise in 10-year bond yields, from 5.2% to 8.0%. Faced with these soaring yields, the federal government was forced to revise and reduce its deficit forecasts.
• France is currently facing higher financing costs because its deficits are considered too large, according to the criteria for inclusion in the euro zone.

The bottom line is that the bond market can dictate a country’s deficit and debt limits. This market power could prevent a new U.S. administration from implementing both tax cuts and import tariffs.

Scenarios still possible between now and the end of 2024

• The most positive scenario would be a rate cut due solely to a decline in inflation, with no pronounced economic slowdown. As of this writing, the U.S. economy is still in good shape.
• A strong U.S. economy, requiring fewer rate cuts, could cause the U.S. dollar to appreciate against other currencies. This would be negative for the Canadian dollar and would keep inflation higher in Canada.
• The final scenario remains reaccelerating inflation with a worsening economy, which would signify stagflation, the most negative situation. This seems less and less plausible as inflation continues to fall. However, more protectionist policies under a new Trump administration could result in a rise in inflation.

Employment situation

In Canada, the unemployment rate fell slightly, from 6.6% to 6.5% in October. Only 14,500 jobs were added, mainly full-time, versus expectations of 27,200. Hourly wage growth remained too high at 4.9% on an annual basis, albeit down from the previous month.

The latest U.S. employment data showed the addition of 12,000 jobs, versus forecasts of 100,000. The hurricanes that walloped Florida seem to have had a very negative impact on employment. The unemployment rate was 4.1%, unchanged from the previous month. Wage growth was still too high at 4.0%.

Economic indicators

Global Purchasing Managers’ Index

The manufacturing segment indicators improved, with more than half of the thirty countries represented posting an index reading above 50 (expansion). The services segment remains robust.

Inflation rate

Overall, inflation is falling and continuing to move in the right direction, which should enable central banks to begin or continue their rate cuts. In 2025, however, the indiscriminate imposition of tariffs on all countries by the new Trump administration could exert inflationary pressures and limit the Fed’s room to manoeuvre.

Benchmark rates in Canada, Europe and the United States

Interest rates have been high for some time now, but several central banks have begun their rate cutting cycle. Upcoming mortgage and corporate loan renewals could force consumers and businesses to reduce their spending now, in anticipation of rates that are higher than initially expected.

Our strategic monitoring

We are monitoring inflation and consumer spending, as well as leading indicators for manufacturing production, the services sector and employment.

Caution and risk management remain our top priorities.

Our tactical approach

In October, we maintained our equity weighting in the tactical allocation strategy, with the economic outlook and market indicators still dictating an overweight position.

In the United States, we maintained our position in large cap growth stocks, which react positively to stabilizing interest rates, as well as in stocks with a track record of dividend growth which are more defensive.

We increased our position in small cap stocks, which react well to rate cuts, and decreased our position in emerging markets, since the strength of the U.S. dollar negatively impacts these countries. We also favoured a return to the euro zone and Japan.

In terms of fixed income, we increased the weighting of Canadian federal and corporate short-term bonds and reduced the weighting of high-yield bonds and emerging market issues.

We continue to favour stocks in developed countries and focus on risk management.

Main risks

• Comprehensive protectionist policies in the U.S., without significant productivity gains, are likely to increase inflation and slow down rate cuts. Our currency would be at a disadvantage, since the Canadian economy is not as strong as that of our neighbors to the south.
• An overly restrictive monetary policy could cause a major recession or other problems, like the U.S. regional bank crisis.
• A monetary policy risk is emerging, as evidenced by the rise in Japanese interest rates, which had a marked effect on all the world’s markets.
• High interest rates for an extended period would result in lower corporate profits and sharply curtail household spending.
• The possibility of an episode of stagflation, i.e. anemic economic growth and high inflation, persists. This situation is negative for stock markets.
• The Israeli-Palestinian conflict could have repercussions throughout the Middle East.
• An escalation of the war in Ukraine could spread to other European countries.
• There is also a risk of worsening tensions between China and the United States over Taiwan.

Data source : Bloomberg

The opinions expressed here and on the next page do not necessarily represent the views of Professionals’ Financial. The information contained herein has been obtained from sources deemed reliable, but we do not guarantee the accuracy of this information, and it may be incomplete. The opinions expressed are based upon our analysis and interpretation of this information and are not to be construed as a recommendation. Please consult your Wealth Management Advisor.