ECONOMIC & FIXED INCOME COMMENT- “Show me the Data”

After proving more resilient than expected in 2023, the global economy is forecast to expand 3.1% through 2024. The International Monetary Fund (IMF) recently revised their global growth estimate upwards by 0.2% on account of greater-than-expected resilience in the U.S and several large emerging market economies, as well as fiscal support in China. While the revised 2024–25 growth forecast is welcomed, it is still well below the historical (2000–19) average of 3.8%. Weighing on global economic activity remains elevated central bank policy rates to fight inflation, withdrawal of fiscal support amid high government debt levels and low underlying productivity growth.

The Canadian economy is performing better than expected to start 2024. In January the economy grew by 0.6% while the flash estimate for February is forecast to expand 0.4%. Taken together, Canadian GDP is expected to grow 3.5% in Q1 (annualized), well above the Bank of Canada’s (BoC) expectation of 0.5%. Going forward, economic growth is expected to weaken due to: sticky underlying inflation, growing number of business insolvencies, increasing household mortgage delinquencies, slowing export growth, declining productivity and soft business investment intentions. Against this backdrop, the Canadian economy is forecast to expand 1.0% in 2024.

During the quarter, the BoC kept the overnight bank rate unchanged at 5.00%. The Governing Council is still concerned about the outlook for inflation, particularly the persistence in underlying inflation. While recent February inflation data of 2.8% suggests monetary policy is working, future progress is expected to be gradual and uneven (see chart). Overall,

we continue to expect both inflation and wage growth to trend lower during the year due to weakening consumer spending and a softening labor market. Specifically, the unemployment rate for March increased to 6.1%% and is forecast to reach 6.5% by year-end.

The BoC is expected to start lowering interest rates mid-year. Currently, money market participants are pricing in a 78% probability of a rate cut in June and 100% probability for a rate cut in July. During the year, the BoC is forecast to deliver 75-100 basis points of rate relief. The BoC will lower interest rates guardedly, being mindful of the potential to reignite the housing market. Furthermore, the BoC will remain cautious as a policy mistake could jeopardize the central banks creditability and the potential for a hard landing.

The U.S. economy will continue to outperform other global economies in 2024. U.S GDP growth is forecast to expand 2.4% buoyed by a robust labour market and resilient consumer spending. The U.S Federal Reserve Board (Fed) maintained the Fed Funds Rate steady at 5.5% during the quarter. Economists were eager to see how the outlook for rate cuts would change given the recent uptick in inflation. Surprisingly the median Fed dot plot still showed 75 basis points of rate relief for 2024. However, the pace for cutting interest rates for 2025 is expected to be slower and the long-term neutral rate to be higher (2.5-3%).

Over the past few months, the bond market has deliberated over the path of interest rates. Year-to date, economic data have remained mixed, causing a persistent and pronounced divergence of opinion among economists regarding the direction of inflation and appropriate level of interest rates. In December, capital markets were confident the U.S. Fed had overcome inflation and would start rate cuts in March totalling 150 bias points of rate relief. However, by the end of the quarter, capital markets trimmed back interest rate expectations to a more modest level (see chart). Consequently, Canadian and U.S bond yields moved higher generating negative returns for the quarter.

As we move into the second quarter, monetary policy will be highly dependent on the path of inflation and overall strength of the economy. While the BoC has started to discuss the possibility of rate cuts, they will take a cautious approach. Specifically, if underlying inflation remains persistent and growth surprises to the upside, the BoC could be on “hold” for longer.

We continue to look for opportunities to lock in attractive yields by extending term (duration). Given the wide range of potential economic outcomes in the near-term, we favour intermediate-term bonds that lock in improved yields while providing a cushion to future volatility without taking on excessive interest rate risk.