CA-EN Institutional
CA-EN Institutional
This week with Sadiq

Will the Bank of Canada Follow the Fed’s Lead?

December 5 to 9, 2022
Share
Share on facebook
Share on linkedin
Share on twitter
Share on email
Share on print

Market Recap

  • Equity markets were modestly changed this week, despite plenty of volatility, including a strong (maybe curious) rally on the back of a speech from Fed Chair Powell.
  • The S&P 500 rose 1.1% when all was done, while the TSX added 0.5%.
  • Canadian bank earnings got underway to mixed results, and the sector lagged on the week, down 1.0%, although there were a few chunky dividend increases.

Dovish Fed Comments

Last week, markets surged on indications from the U.S. Federal Reserve that it is prepared to slow the pace of interest rate hikes. But was this reaction premature, and will it affect the Bank of Canada’s rate decision this week? Even before the Fed’s comments, markets’ expectation was that the next increase would be 50 basis points rather than 75. What the market was really happy to hear was that the terminal rate is unlikely to go higher than previously expected. That was a more dovish, or at least a less hawkish, statement than we’d heard previously from the Fed, and markets viewed it as something of a pivot, hence the positive reaction. Our evaluation, however, is that markets are still pricing in a rate cut sooner than we’re likely to get it. And they’re also underestimating how long we’ll stay at the terminal rate once we reach it. As for this week’s rate decision, the Bank of Canada doesn’t necessarily have to follow the Fed’s playbook—it’s entirely possible that we could see fewer rate hikes in Canada than in the United States, especially as the economy starts to weaken on the back of a weaker consumer. We do expect the Bank of Canada to continue to raise rates for now, but we don’t expect them to be as aggressive as they are south of the border.

Bottom Line: The Fed’s slightly dovish comments were good news for markets, but investors may still be underestimating how long higher rates will last—at least in the U.S.

China

After mass protests in China against the country’s zero-COVID policy, there are indications that the government may be ready to enter a new phase, loosening restrictions and allowing some virus-infected people to isolate at home. For Chinese stocks, this is good news—they’d already been on a tear recently on speculation that these strict policies could be relaxed, and now, it seems to be coming to pass. But the question remains—what will these new policies actually entail and when will the be fully implemented. On top of that, China is currently going through an outbreak, so it may not be an ideal time to introduce a looser policy. We do think that going forward, people will have to isolate for less time, which is a positive development. It will likely be Q2 or Q3 of 2023 before we see a full implementation of this policy and China returning to a more fully open economy. In anticipation of this rebound, we expect the outlook for Chinese stocks to be good over the next 12 months. But it could still be a bumpy ride if wider COVID outbreaks occur, which could dampen economic activity for one or two quarters.

Bottom Line: The loosening of COVID restrictions in China is a positive sign, but questions remain regarding of the implementation of new policies and the possibility of new outbreaks.

Canadian Banks

Canada’s Big 6 banks have reported their Q4 earnings, and it was a bit of a mixed bag, with half beating expectation and half falling short. These results reflect the overall state of the Canadian economy—not necessarily bad, but not firing on all cylinders either. (This is one of the reasons why the Bank of Canada may not follow the Fed’s lead, as mentioned earlier.) In general, the banks are still in good shape, though worries remain around loan loss provisions and the impact housing and higher mortgage rates may have on consumer sentiment. Trading activity has declined because of markets being down for most of the year. But as markets continue to rebound, the outlook for Canadian banks will likely be more positive going forward, especially as we approach the end of this interest rate cycle. If there was one surprise in this round of earnings, it’s that we did see most banks increase their dividends. That’s another positive sign, signaling that even if this quarter may not have been great, the banks aren’t too worried about outlook going forward and their balanced sheets look healthy.

Bottom Line: The Big 6 are in decent shape and appear to be taking a long-term view—as they should.

Positioning

As we head into the end of the year, our team’s evaluation is that we’re likely to see a continuation of the recent rally in equity markets, though at much slower pace. Given recent dovish statements, we don’t see any surprises coming from the Fed at their December meeting that would potentially cause markets to decline harshly. We do, however, think that markets are still a bit ahead of themselves, and that we could see some selling off of this rally as we get into 2023 and into the next quarter’s earnings season. Inflation is also a factor—if it stays relatively high, meaning above 5%, there could be a pullback in markets following the strong run-up we’ve seen in November and December. Fixed income, for its part, is continuing to look more and more attractive. For now, our positioning is still neutral, because we expect a few more interest rate hikes. But once we’ve seen one or two of those come through, we’re likely to move to slightly bullish. We also still have some cash, but it’s not because we don’t see opportunities—it’s because we want to hold some in reserve to capitalize on the pullback we may see in early 2023.

Disclosures:

The viewpoints expressed by the Portfolio Manager represents their assessment of the markets at the time of publication. Those views are subject to change without notice at any time without any kind of notice. The information provided herein does not constitute a solicitation of an offer to buy, or an offer to sell securities nor should the information be relied upon as investment advice. Past performance is no guarantee of future results. This communication is intended for informational purposes only.


BMO Global Asset Management is a brand name under which BMO Asset Management Inc. and BMO Investments Inc. operate.


Any statement that necessarily depends on future events may be a forward-looking statement. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although such statements are based on assumptions that are believed to be reasonable, there can be no assurance that actual results will not differ materially from expectations. Investors are cautioned not to rely unduly on any forward-looking statements. In connection with any forward-looking statements, investors should carefully consider the areas of risk described in the most recent simplified prospectus. This article is for information purposes. The information contained herein is not, and should not be construed as, investment, tax or legal advice to any party. Investments should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance.


This article is for information purposes. The information contained herein is not, and should not be construed as, investment, tax or legal advice to any party. Investments should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance.


Commissions, management fees and expenses (if applicable) all may be associated with investments in mutual funds. Trailing commissions may be associated with investments in certain series of securities of mutual funds. Please read the fund facts, ETF facts or prospectus of the relevant mutual fund before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Distributions are not guaranteed and are subject to change and/or elimination.


For a summary of the risks of an investment in the BMO Mutual Funds, please see the specific risks set out in the prospectus. ETF Series of the BMO Mutual Funds trade like stocks, fluctuate in market value and may trade at a discount to their net asset value, which may increase the risk of loss. Distributions are not guaranteed and are subject to change and/or elimination. BMO Mutual Funds are managed by BMO Investments Inc., which is an investment fund manager and a separate legal entity from Bank of Montreal.


®/™Registered trademarks/trademark of Bank of Montreal, used under licence.

Reccomended

article collection

Mutual Funds

Men
Sadiq Adatia
Weekly Commentary
January 30, 2023
January 2023

How Bad Will the Layoffs Get?

Is the current earnings bounce likely to continue? Are layoffs spreading to sectors beyond tech?
Men
Sadiq Adatia
Weekly Commentary
January 23, 2023
January 2023

Bonds, A Comeback Story

Where are the opportunities in the bond market? Are we at an attractive entry point for real estate investing?
Men
Sadiq Adatia
Weekly Commentary
January 16, 2023

Are Rate Cuts on the Horizon for 2023?

What did we learn from the latest CPI numbers? Do more tech layoffs lie ahead?
Men
Sadiq Adatia
Weekly Commentary
January 9, 2023

Our 2023 Portfolio Strategy Overview

Which two sectors are BMO Global Asset Management most bullish on for 2023? What investment factors are poised to outperform? Where are the bright spots in the bond universe?
Responsible Investment
January 3, 2023
January 2023

Understanding and Respecting Indigenous Rights during the Low-Carbon Transition

Consideration of Indigenous rights is critical to achieving our energy transition goals.
Men
Sadiq Adatia
Weekly Commentary
December 19, 2022

Looking Ahead to 2023

Why are markets shifting their risk focus from inflation to recession, and how did they react to the Fed’s latest announcement? What’s the outlook for U.S. markets in 2023?