Interest Rates & the Economy


At the close of business last Friday, global equities were lower on the week amid a rise in long-term interest rates and concerns that China may be targeting US technology companies in retaliation for US export bans. The yield on the US 10-year Treasury note reached 4.30% at midweek before easing to 4.25% on Friday. The price of a barrel of West Texas Intermediate crude oil rose to $87.60 from $85 last Friday as Saudi Arabia and Russia extended production cuts. Volatility, as measured by the Cboe Volatility Index (VIX), rose to 14.5 from 13.3 a week ago.



September is traditionally a tough month. However, we remain optimistic for strong returns for the balance of this year. As I mention later in this week’s newsletter, we expect interest rates to stay higher for longer, but we also think that we are headed for a mild recession in 2024, which means interest rates will finally start to decline in the new year. Equities in the right sectors remain favourably priced and long-term Canadian government and corporate bonds are looking particularly attractive. As always, owning a diversified, balanced portfolio instead of trying to pick a few stocks you think will work is a more successful strategy for long-term investing.



The Bank of Canada held rates steady at 5%, as expected. Canada reported nearly 40,000 new jobs in August while the unemployment rate held steady at 5.5%. Our central bank has confirmed that we have come a long way in the past year. They tell us that monetary policy is working, and inflation is coming down. With past interest rate increases still working their way through the economy, monetary policy may be sufficiently restrictive to restore price stability. What this says to us is that we are likely at the end of the tightening cycle, but the focus on the 2% inflation target means interest rates are likely to stay at these levers longer than expected. In addition, we now believe that when interest rates begin to decline in 2024, we are more likely to see short-term rates come down to the 3% range as compared to 1% at the start of the tightening cycle.



The yield on the US 10-year note has risen more than 20 basis points since last Friday’s employment report, reaching as high as 4.30% on Thursday, as huge amounts of investment-grade corporate issuance came to market after summer drew to a close on Labour Day. Tuesday alone saw $36 billion in new corporate bond supply come to market. But supply was not the only factor influencing yields this week. Also pushing rates higher was a stronger than expected ISM services reading of 54.5, the highest level in six months. News that Saudi Arabia and Russia will maintain their voluntary oil production cuts through year-end contributed as well, sending Brent crude above $90 a barrel. Weekly jobless claims, at 216,000, the lowest weekly number since February, belied last week’s softer US employment report and added to upside rate pressures, as did upwardly revised US budget deficit projections.

This past week, the US dollar index reached its highest level since March, when it peaked just prior to the US regional banking crisis. This is an issue we are following closely, but we do not believe it will be anywhere near as severe as the 2008 financial crisis. US regional banks are even more exposed to commercial real estate than it appears. Over the past decade, banks have increased their exposure to commercial real estate in ways that aren’t usually counted in their tallies. As a group, they lent to financial companies that make loans and they bought bonds backed by the same types of properties. That indirect lending—along with foreclosed properties, trading portfolios and other assets linked to commercial properties,  brings banks’ total exposure to commercial real estate to $3.6 trillion or about 20% of their deposits.

On the good news front, several US monetary policymakers spoke late this past week, helping to cement the view that a hike at this month’s FOMC meeting is unlikely. New York Fed President John Williams said Thursday that monetary policy was “in a good place” and that sifting through incoming data will determine whether policy is sufficiently restrictive enough to return inflation to the Fed’s target. Futures markets agreed, pricing in only a 7% chance of a September hike.



As Europe prepares for winter, the liquified natural gas operation in Western Australia is facing a strike by its workers. If a strike is lengthy, it may mean a significant problem for global supplies.

The US and Australia have been large suppliers of liquified natural gas to Europe, and this development is likely to keep prices at elevated levels globally.



On Thursday, the yuan traded at its lowest level against the US dollar since 2006, and USD/JPY has reached levels close to those reached when the Bank of Japan was forced to intervene to strengthen the yen in October of last year. China and Japan remain monetary outliers, maintaining super loose (in the case of Japan) or slightly easier (in China’s case) interest rate policy.



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