The Upside: Rates explained – How do the Bank of Canada’s decisions affect you?

[00:01:30] Emily Anonuevo: Hello, and welcome to The Upside. I'm your host, Emily Anonuevo. Both the Bank of Canada and the Federal Reserve announced yesterday that interest rates would remain unchanged. In Canada that means its key lending rate stays put at 2.75%, and in the U.S. at 4.25%. This is the fifth straight time the U.S. has held [audio cuts out]. In Canada the BoC says the decision to hold came with a clear consensus. As we come to the midway point of the year with rates steady, inflation sticky and tariff uncertainty still an issue, what does this all mean for the average investor, their investments and their wallets? Joining me today to discuss the impact of these rate decisions and more is portfolio manager, David Tulk. David, welcome.

[00:02:13] David Tulk: Thank you for having me.

[00:02:14] Emily Anonuevo: Thanks for being here, I know it's a busy time. Let's get straight into it. Like I said off the top, BoC, Federal Reserve, came out with the rate announcements on the same day and they decided to hold rates. Now, what are your initial thoughts and was this an opportune time for them to possibly make a move and do something significant?

[00:02:34] David Tulk: I think their decision to not move may not be the most exciting thing that we've ever seen but that's not to say there's not a lot going on under the surface. I think both central banks are facing a pretty clear tension right now because, as you mentioned, inflation is still sticky so that tends to focus their minds on keeping rates elevated to make sure that inflation doesn't get out of control. At the same time, the tariff uncertainty and some risks to maybe slowing economic growth and a rising unemployment rate do open the risk that at some point they're probably going to have to ease policy. When you have these two things that are pulling in opposite directions I think the path of least resistance is to just stay put, sit on your hands and just try to get a little bit more clarity on a lot of these sources of uncertainty that really do cloud the outlook today.

[00:03:24] Emily Anonuevo: Typically, central banks will cut interest rates if they see that the economy is weakening. Now, both parties are saying that they're not seeing that despite the tariff issues but Governor Macklem did say that the BoC came to a clear consensus. On the U.S. side there are a few reps that voted against it. Where do we stand there?

[00:03:45] David Tulk: That's a really interesting dynamic. It is a committee on both sides of the border. There tends to be more formal voting results that are released within the United States. As we know, there has been an overlay of politicization of the Federal Reserve. We have the president who is advocating for lower interest rates, and doing so very vocally. That, I think, has raised some scope for members of the committee who might be trying to negotiate for a job interview for the next role of the Fed chair, which is next year. That is something that might be motivating some individuals but I think it really does speak to an underlying sense of uncertainty right now because two well-trained economists can look at the same set of economic data, understand the same risks that face the outlook and can come to very different conclusions. That really, I guess, encapsulates how hard it is to be a central banker with all of the stuff that's going on right now.

[00:04:43] Emily Anonuevo: Now, you were a former economist with the Bank of Canada, let's dig into that a bit because I'm interested to know what considerations are put into place when thinking about cutting rates, holding rates, raising rates. What goes into that whole process, David?

[00:05:01] David Tulk: Inflation is job number one for a central banker. It's probably really job number one, job number two and job number three, because it is really, really important. One thing that monetary policy generally is really good at is helping to keep inflation low and stable. That is the policy instrument. It's a really important dynamic that, as we've seen in recent years through the pandemic, that when inflation does get out of control it is a real hit to the standard of living of every Canadian. Central banks take that responsibility very seriously, so keeping an eye on inflation really is what they're trying to do and how they're trying to set policy, but a lot of other things can influence inflation so they need to be very conscious of what's happening to the rest of the economy. The unemployment rate, economic growth, all of these other factors will influence inflation. Now, the challenge that I think central banks face is that when they change interest rates, say, today, it only really impacts inflation in a year's time, to a year and a half. They are making a decision now that really doesn't ... they won't really see the impact of that decision for a year and a half. That allows for a lot of things to happen in between now and then and a lot of shocks can arise that can push the economy off course. Having a good economic forecast if you're a central bank is really important.

[00:06:21] A lot of the job that central banks do ... they certainly focus on inflation but how they focus on inflation is they really try to spend a lot of time building these robust economic models to try to figure out what the likely path is of the economy. That was one of the things that I spent a lot of time doing at the bank was building and running models that help drive an analysis and understanding of the Canadian economy. Now, I think a related challenge to that, and this is something that the Bank of Canada has done, is that there is just so much uncertainty right now that they've given up trying to have one economic forecast. They've now moved to a world where they do scenarios. Now there's two states of the world. There's a good state where tariffs go away and things are fine, and then there's a bad state where tariffs maybe get worse or other factors get worse. They need to figure out where in that blend between a good world and a bad world they sit. That's helping to drive their policy decisions.

[00:07:16] Emily Anonuevo: Now that we've passed the midway point of the year and these rate announcements have passed, I think there are just a couple more from both central banks, I feel like we're in this moment of time where we're still waiting with bated breath, a tipping point in the markets where something may happen, like you mentioned, maybe a shock in the unemployment numbers or inflation as well. Where is that tipping point? When could it actually happen and what are your views on that?

[00:07:45] David Tulk: I think there's a lot of things that can certainly happen within the economy. We're facing a trade deadline supposedly on August 1st o we'll see what is negotiated between now and then. We're in sort of the 11th hour, if you will, of that type of arrangement but that's not the only line in the sand. There can be many other trade developments that happen between now and the foreseeable future. That's just one potential challenge that I think the Bank of Canada and other central banks are wrestling with. We also have dynamics within the labour market more generally. We still have a pretty challenging outlook for the household sector in Canada as debt levels are still pretty high. Interest rates have come down somewhat in recent years but they're still at a level that ... people who are refinancing mortgages over the next year or so will face considerably higher mortgage rates. There are a lot of other things going on. I think if you're a central bank, again, it really just comes down to that tug of war between inflation and economic growth.

[00:08:41] If there's the sense that inflation is still sticky and elevated, and there's reasons out there to think that it might stay sticky and elevated for longer then, again, they're inclined to probably keep rates unchanged. That's probably my expectation for the rest of this year, unless you see something really go wrong in the rest of the economy the odds are that interest rates will stay more or less at their current level. Again, if something happens where they need to respond to, there, I think, they're more inclined to probably cut interest rates as compared to hiking interest rates today. Again, the more likely scenario is they're just going to sit on their hands, wait for some of this uncertainty to clear and try to get signals from not just the trade side of the economy but lots of other signals as well.

[00:09:25] Emily Anonuevo: I guess we just have to wait and see. Now, David, you are part of the GAA team, the Global Asset Allocation team. In terms of where we stand now what is the team's positioning at this point in time?

[00:09:36] David Tulk: In terms of how we're structuring our portfolios, the first decision we make is really how much risk we want to have on in the market right now. That can be boiled down into a stocks versus bonds call in terms of the asset allocation funds that my team manages. Generally speaking, we're trying to keep fairly close to benchmark. That means not a huge allocation into stocks relative to bonds. That's, again, just partly a reflection of the uncertainty that we see in a lot of different factors that are out there. That's hard to have a lot of conviction in this type of market when it comes to that tilt between stocks and bonds.

[00:10:17] Where we have, I think, a lot more conviction is where we want to be invested in terms of allocations around the world. Again, relative to our benchmark, which is a globally diversified benchmark, we are generally leaning outside of the United States at this point. That's not to say that every U.S. company is challenged but I think what is challenging the U.S. right now is the currency. The U.S. dollar has fallen pretty sharply relative to the Canadian dollar, relative to other currencies around the world.  I think the policy mix that we're getting out of the U.S. administration today is likely to push the U.S. dollar lower still. As a result, when we think about where in the world we want to be allocated to we would rather be allocated outside of the United States relative to the U.S. Most of that is in Europe and Japan and other international markets.

[00:11:08] On Canada, we're a little bit closer to being neutral but that is, again, a tension into itself where there are reasons to say that because the U.S. is struggling Canada might do a little better by comparison, but the links between Canada and the United States just mean that we can't have enough confidence in that to take a very clear overweight into the Canadian equity market at this stage. Really, when we think about that regional allocation that's the view that we have the greatest degree of conviction in today.

[00:11:38] Emily Anonuevo: Let's switch back to tariffs and the trade deals. Now, the deadline for a trade deal between the U.S. and Canada is looming, August 1st. Now, the U.S. has made deals in the recent weeks with Japan, Europe and India, does this bode well, a positive sign for Canada that maybe we could strike a deal with the U.S.?

[00:11:58] David Tulk: It certainly seems that the U.S. is in a deal-making frame of mind, if you will. We have seen those deals with other countries and you get the sense that the U.S. is moving down the list of countries that they need to negotiate with. I know there are negotiations certainly going on between Canada and the U.S., even probably as we speak right now they're talking. There are some certain sticking points that I think have challenged the negotiations thus far. We have seen sort of more persistent tariffs on steel and aluminum and on autos. There are some things that I think people are very mindful of that will take more than just a simple negotiation to try to resolve. We also have Prime Minister Carney who has said very publicly that he won't take a bad deal. Canada does have some cards to play in this relationship as well. I think that negotiation is taking place and I almost want to think that the longer it takes to come to terms, that might actually be a good thing because that would suggest that Canada's not necessarily backing down in the face of pressure.

[00:13:00] Some that have done a very critical analysis of the trade agreement with Europe have concluded that Europe did cave on some issues and this was a deal that was very much benefiting the U.S. at the expense of Europe. I don't think we want to fall into that same trap or feel pressured to make a deal over the short term. The right deal will take the time it takes. If it's August 1st, that's great, but if it takes longer then that's just the reality that we're living in.

[00:13:27] Emily Anonuevo: David, I know that we can't look into a crystal ball and look into the future but Bank of Canada, Federal Reserve, a few more announcements on their belt towards the end of the year, what do you think their next move?

[00:13:40] David Tulk: I think the path of least resistance is probably just keeping rates unchanged. Again, it's that tug of war between all these different factors. We have seen more economic resilience than we might have expected before, which is unambiguously a really good thing for Canada, but there are still pockets of weakness that we need to be mindful of and shocks that could occur. As I mentioned, I think the next move is more likely to be a cut relative to a hike but I do think that the timing around that is probably later than what many in the market think today.

[00:14:12] Emily Anonuevo: As investors move on throughout the year, a lot of uncertainty, a lot of negative headlines, how can they parse through that and, basically, protect their investments going forward? What can they do?

[00:14:25] David Tulk: That's a great question and a really important topic to discuss. I think the first thing is that investors need a plan. There's a lot of uncertainty, there's a lot of things that are happening. Headlines can be overwhelming if you're observing the financial media frequently. It can feel really just entirely over the top. Having a plan, working with a financial advisor I think is something that is really good because that will anchor your goals so you're not just focused on the next headline or the next week or the next month, you'll have an objective that really fits the horizon over which you want to invest. That naturally allows you to make better decisions, I think, because you're not trying to recoup losses from a prior decision or you're not trying to chase a theme or a trend, you're really, again, focused on a horizon that makes sense for you as an individual.

[00:15:13] I think a related theme also, and this is really befitting the type of world that we're living in right now, it pays to be diversified. Again, nobody has a crystal ball, nobody has a lot of sense on how a lot of these things will unfold so if you can have asset allocation into different markets, different types of asset classes that do different things for you, that some provide you a defence against weaker markets, some part of your portfolio can be more aggressively tilted towards economic or market optimism, but having a bit of both, I think that allows you to just weather a lot the shocks and the volatility that we've seen thus far this year and are likely to see for the balance of the year and into next year as well.

[00:15:54] Emily Anonuevo: Excellent. David, thank you so much, as always, being here, providing your insights. Really appreciate your time today.

[00:15:59] David Tulk: It's entirely my pleasure. Thank you.

[00:16:02] Emily Anonuevo: And thank you for watching The Upside. You can find more investor content on fidelity.ca under the Investor Education section. You can also sign up for the Upside newsletter where you can get more information on upcoming webcasts. Thanks so much for watching and hope you'll join us again on the next Upside.