The week in the markets -
January 27, 2023

Is it the beginning of the end of interest rate hikes?

We saw what high inflation could do to the global economy last year. The rapid reopening caused a lot of headaches for businesses and consumers around the world. In order to slow down the global economy (to curb inflation), central bankers increased their key lending rates rapidly last year. This week, the Bank of Canada increased its benchmark interest rate by a quarter of a percentage point (25 basis points) and it expects to hold rates here for the foreseeable future. After eight consecutive rate increases, this brings the key rate to 4.5%, which means more borrowing costs for consumers carrying variable debt. “We are trying to balance the risks of under- and over-tightening,” Tiff Macklem, governor of the Bank of Canada, said. “If we do too little, the decline in inflation will stall before we get back to target. But if we do too much, we will make the adjustment unnecessarily painful and undershoot the inflation target.” The last time rates were this high was in 2007.

Looking south, we believe that the U.S. Federal Reserve is likely to increase its interest rate by an additional 50 basis points, before it pauses. When U.S. interest rates are higher than Canada’s, this can lead to a weaker Canadian dollar. Interest rates are likely to be higher in the U.S. for some time, which can lead to investors selling Canadian dollars to buy American bonds that can deliver higher interest. This will reduce the value of the Canadian dollar. Global oil prices, which can strengthen the loonie, are unlikely to go above the US$70-85 per barrel range. This means that, over the next six to 12 months, the loonie is likely to be valued at between US$0.73 and US$0.76. 

U.S. gross domestic product (GDP) was also published this week, showing the effect of these higher rates on growth. GDP rose at a 2.9% annualized pace, down from 3.2% in the third quarter. The U.S. economy continues to meet expectations of market watchers, showing a mild slowdown that the U.S. Federal Reserve wanted to see, as it attempts to tame inflation without stifling growth.

Looking at signs of inflation cooling, we’ve seen shipping costs for moving containers from Asia to the U.S. fall dramatically since the summer; the benchmark price has dropped over 86%. A report from the International Monetary Fund stated, “While skyrocketing food and energy prices were making headlines, the surge in shipping costs seemed to pass largely under the radar, despite its potential inflationary impact… Given the actual increase in global shipping costs during 2021, we estimate that the impact on inflation in 2022 was more than two percentage points — a huge effect that few central banks would dismiss.”¹