The Upside: Understanding how the BoC’s rate decision could affect your financial future

[00:00:22] Jordan Chevalier: Hello, and welcome to The Upside, I'm your host ,Jordan Chevalier. Today we're joined by Ilan Kolet, institutional portfolio manager and member of Fidelity's Global Asset Allocation, or GAA team. Ilan helps manage billions of dollars on behalf of Canadians. He's here today to discuss the latest Bank of Canada rate decision, what it means for Canadians and what could be next. We'll also dive into the latest tariff news and unpack the U.T. tax bill. Ilan, thanks for joining us today.

[00:00:51] Ilan Kolet: Thanks Jordan. Great to see you.

[00:00:53] Jordan Chevalier: The Bank of Canada, they held its policy rate, what are your sort of initial thoughts? Were you expecting it here? What are we thinking?

[00:01:00] Ilan Kolet: It's really interesting, right? Things are getting really interesting. Just as a reminder, myself, David Tulk, David Wolf, 20 plus years combined experience at the Bank of Canada. We follow the developments closely and sort of microanalyze every single statement that comes through. What I would say here with the Bank in Canada is it's actually not that interesting at the moment. I know that's probably not the way we wanted to lead off the discussion but the Bank of Canada is in a wait and see, data-dependent, ready to react sort of mode. That line, ready to react, which we've heard several times at press conferences, is the right approach to take. The reason it's the right approach to take is because of the incredible level of uncertainty around tariffs and trade policy the Bank of Canada doesn't want to react in such a way to lower rates ahead of time in the event that these tariffs get negotiated away and now they're overly stimulative with inflation not really where they want it and then they have to kind of reverse course. This ready to react, wait and see, data-dependent approach is the right move right now. That's exactly what we got.

[00:02:18] What I would say is the likelihood, and I know we're going to talk about tariffs, the likelihood that tariffs actually do show up in terms of a slowing is probably already here. Households holding more precautionary savings, companies kicking hiring and capex plans and this will hit the Canadian economy and will likely result in rate cuts at some point this year. For right now what we saw recently, what we saw yesterday was a wait and see, data-dependent approach focusing really on that near term information. The last point I'd mention there is central banks have one job, low and stable inflation, generally. Inflation is not where it needs to be in Canada. We're getting there, we're much better than we were a few years ago but we're not where we need to be. With inflation sort of stubbornly elevated you don't want to preemptively cut rates when you don't have that inflation right at target. We're not at target yet.

[00:03:19] Jordan Chevalier: There is sort of a sweet spot that the Bank of Canada is going to say this is the rate we want it to be at.

[00:03:24] Ilan Kolet: Exactly. That's changing all the time. It's unmeasurable, the so-called R-star neutral rate. I know we don't want to get too nerdy but that neutral rate of interest is very, very hard to assess. The Bank would love to be done. If we could snap our fingers and tariffs went completely away and all the uncertainty went away the Bank, and even the Fed for that matter, would love to be done. That's not the world we live in. They have to sort of guard against two different scenarios. The first scenario, and they laid this out beautifully in their April monetary policy report, which is very accessible, I would say, that section is a really interesting read.

[00:04:03] Jordan Chevalier: When you hear April monetary report you think, oh my goodness, it's going to be...

[00:04:07] Ilan Kolet: They've done a really good job, the Bank has done a really great job of making those monetary policy reports accessible and readable to Canadians, the people that they serve. Scenario one is tariffs get negotiated away, that's a slowing in growth. Scenario two is much scarier and something that would result in a totally different path for policy. Right now the right stance for the bank is a wait and see approach, data-dependent and ready to react. Ready to act is the line that they've all said this is going to be our line, the key message.

[00:04:42] Jordan Chevalier: Has that approach and has the pause affected the Canadian dollar at all? What are we seeing there maybe over the last month or month and a half?

[00:04:51] Ilan Kolet: The Canadian dollar has been really ... again, a really interesting move in the Canadian dollar. Canadian dollar has appreciated measurably. It started the year in that 69 cent range, we're sitting around 73 cents as of yesterday. That's a measurable appreciation, pretty significant appreciation, I'd say. The reason for that appreciation is less to do with sort of anything remarkable or incredible happening in Canada and more that end of U.S. exceptionalism. It's not impossible for the Canadian dollar to depreciate when the U. S. dollar is depreciating but in general, if the U.S. dollar is appreciating the Canadian dollar is appreciating. What we've seen is ... all of last year I spent every presentation and every road show and every Fidelity Connects was about the remarkable level of U.S. exceptionalism. It was justified, the exceptional level for the U.S. dollar and valuations and now that exceptionalism has come under threat.

[00:05:55] This is something we talked about in our Q2 paper, Elbows Up. The U.S. dollar is depreciating and it's depreciating because the underpinnings of U.S. exceptionalism have come under attack. In the event of a broad U.S. dollar depreciation the Canadian dollar is going to appreciate. That's what we've observed so far. It didn't move that much, I would say, with the Bank of Canada decision yesterday. We don't look at day-to-day movements, that's not how we kind of manage the funds. With the general appreciation I will say of the Canadian dollar, depreciation of the U.S. dollar we have, essentially, removed our exposure to that U. S. dollar weakening in the funds, which is another way, another layer that we can help underlying investors sort of preserve capital and do well in the funds that we manage for them.

[00:06:46] Jordan Chevalier: That's great. Very well said. I know a lot of questions are coming and I'm sure you're getting them as well, U.S. trade policy. We've discussed it a little bit, the latest item being this doubling of the tariffs now to 50% from the U.S. coming into Canadian aluminum and steel. What do we have there? Are there any things that investors should be watching or looking for? Sort of a quick review.

[00:07:09] Ilan Kolet: Tariffs, this is an interesting one to talk about. By the time we're done this discussion it might be different.

[00:07:18] Jordan Chevalier: In 20 minutes it could be...

[00:07:18] Ilan Kolet: Exactly. Please back away from the keyboard is sort of the message. Jokes aside, at a high level tariffs could be exceptionally damaging for Canada. Let's lay out a few numbers just to sort of set the stage. When we're interpreting and analyzing the effect of tariffs there's three assumptions we need to make. How big is the tariff? Is it 25, is it 50, us there a carve out for USMCA, is it 107 like it was on China for a few days, what's the number? Two, what's the list? Is it everything, is there a carve out, is it one or two items, is it steel at a higher rate? The third assumption that we need to make is how long do these last? Is this a negotiating tool, is this permanent new level for everybody? We've talked about this before but the most honest answer to those three questions is I don't know, I don't know and I don't know. The way to put tariffs into perspective is the following, 30% of Canadian GDP is exports. To put that in perspective 10% is housing. So trade, exports, have three times the impact than new construction in terms of Canadian growth. That's enormous. 80% of those exports go to one place, you guessed it, United States. So 20%-ish of Canadian growth just by itself are exports to the U.S. That is exceptionally high. It's no surprise that we're particularly vulnerable.

[00:08:45] I think there's sort of two paths ahead of us. Again, I think the Bank of Canada did a good job of explaining this. The first is tariffs get negotiated away. This is a slowing in growth as households, Canadian households, folks listening to this kind of hold more funds, precautionary funds, keep it out of an investment account because they want to hold more precautionary funds and two, firms kick the can on hiring and capital spending. Businesses don't like uncertainty and that's uncertainty. Then they get negotiated away and then we kind of come back to a more normal growth environment in Canada.

[00:09:23] The second is 25% tariffs permanently on everything forever. That's a very, very negative scenario. That's a serious recession, that's a depreciation of the Canadian dollar, an upward shock to inflation. It's a very, very bad scenario. I don't actually think, and most of us don't think we're going to end with that exceptionally negative scenario. We'll probably end up with something that resembles something closer to scenario one. I was in DC a couple of weeks ago with an association that I'm a part of, we had meetings at the Treasury Department with senior officials. They're closed-door meetings and we can't really discuss who said what but the general takeaway from me from those discussions is things are going to be choppy and messy until there is an agreement and signatures are signed and hands are shaken. Then we are on the other side of that with something that looks like a more permanent solution to this trade uncertainty. In the context of our funds what that means though is we have to be diversified across regions and we have to build in defensiveness into the portfolios to help investors still achieve their goals.

[00:10:39] Jordan Chevalier: There is almost a wait and see approach, especially when we're looking at tariffs. They seem to double, they could just as soon be halved or completely eliminated.

[00:10:50] Ilan Kolet: Exactly. It was very, very jarring when borders sort of got thicker. We sort of saw that at the start of this year but given the volatility in the announcements and in the policymaking I think what that really signals is this ... I mean, the U.S. used to be a stable and predictable economy, stable policymaking and in the event of this sort of volatility, policy volatility, if you will, it means we have to position the funds in such a way to be a bit more defensive, so lean away slightly from the U.S. Still plenty of U.S. in our funds but lean slightly away and right now sort of lean into Europe. Europe is showing signs of galvanization which, again, we haven't seen in decades.

[00:11:35] Jordan Chevalier: There was a little bit of [crosstalk] relationship there but certainly not to this level. Can you speak a little more about that? Maybe where in Europe or things, maybe signals that investors could be looking for?

[00:11:46] Ilan Kolet: In the past when I was on the road people would ask, well, what are your views on Europe? I would sort of joke, I love going to Europe but Europe's a terrible place to invest. Wonderful place to visit, terrible place to invest, I said jokingly because for any investor or advisor listening, any dollar invested in Europe over the last 15 years instead of the U.S. would have been poorer performance. Last year I was getting questions like, why would I own anything but the U.S.?

[00:12:15] Jordan Chevalier: Mag Seven, slap it on and that's it.

[00:12:16] Ilan Kolet: Exactly. Now we're seeing the benefits of diversification. Right now one of the most important overweights in the funds that we manage is to Europe, is to the European asset classes, European stocks. That's been incredibly helpful. We know what's happened year-to-date. In that paper that we wrote in Q2, we put a really cool chart in that paper. I mean, I love all my charts equally but...

[00:12:42] Jordan Chevalier: Sure, but maybe a little favouritism.

[00:12:44] Ilan Kolet: A little bit. We put a neat chart in there showing German defence spending as a share of GDP, which was 1% for 20 years. We heard about that through Europe not meeting its NATO targets and stuff like that. Something happened in the start of this year that has led to a lot of European nations saying, well, we have to loosen up the fiscal constraint. German defence spending has hockey sticked higher. That's shown up in the markets, in individual names and we're leaning into that as asset allocators as well to take advantage of that. We have to lean in and out of asset classes, styles, sectors, geographies and currencies, that's how we add that additional layer of return.

[00:13:29] Jordan Chevalier: Staying with U.S. policy a little bit, another sort of high news item or a popular news item is the U. S. tax bill. Can you break that down a little for maybe people who haven't read past the headline and maybe want to know a little bit more?

[00:13:42] Ilan Kolet: This change is a lot, there's a lot going on. Really, the bill is projected to support cyclical growth potentially offsetting the drag from tariffs, estimated 1% of GDP of stimulus in 2026. What I'd say here is there are concerns really around the fiscal irresponsibility, rising bond yields and claims that growth and tariffs will offset the debt increase. That seems sort of optimistic in our view especially given delayed spending cuts and assumed future tax hikes. I would say for investors, though, what this bill means is it may support risk assets in the near term through stronger corporate earnings and sort of reduce recession risk but it also raises medium term concerns around Treasury supply, long term fiscal sustainability. What I would say is, again, for us at a high level around the U.S. it's this underpinnings of exceptionalism sort of coming under attack. For us it means the right asset allocation decision for us is to sort of lean away from the U.S. Still plenty of U.S. in these funds just leaning away and looking elsewhere for sort of opportunities from an asset allocation perspective.

[00:15:00] Jordan Chevalier: Staying with the bill a little bit longer, are there signals that you're looking for, things that you're saying, okay, once this happens then we can shift or allocate in a certain direction.

[00:15:10] Ilan Kolet: The best answer to that is this is how we work with our researchers. We have a fantastic dedicated team of asset allocation researchers, the team I used to sit on when I was in Boston from 2014 to the middle of '21. We have folks that have deep experience thinking about policy, fiscal, both monetary policy and fiscal policy. We really rely on these researchers to give us sort of the nuanced view around U.S. fiscal policy and what it might mean for investable asset classes. That's a key input into our research process and we'll continue to do that and that's how we'll sort of navigate things going forward.

[00:15:51] Jordan Chevalier: Maintaining focus on that research on a day to day.

[00:15:54] Ilan Kolet: Exactly. It's the answer to every single question you could ask is research.

[00:15:57] Jordan Chevalier: What are the analysts thinking?

[00:15:59] Ilan Kolet: Research, exactly.

[00:16:00] Jordan Chevalier: Ilan, this has been a fantastic discussion. I wanted to kind of pick your brain right before we end off here. Any kind of final thoughts, things that you want investors ... as we move through the new cycle, tariffs, tax bills?

[00:16:17] Ilan Kolet: Given the news flow and given the volume of news that we're all consuming it's natural at times to get that negative reinforcement through news, through media, through the socials. What I would say is this year is one of those years where the benefits of a well-diversified portfolio and conversations with your advisor are really, really critical. Even though we know that year-to-date the news out of the U.S. financial markets in particular have been kind of scary. One thing I've been saying, and I said this yesterday in Vancouver, last week in Halifax, in Ottawa and the week before, well, I've been on the road a lot, really, over the last few months is the news is not your statement. Maybe turn off the news and kind of call your advisor and have a thoughtful discussion with them about your objectives and how those Fidelity funds have done. It's not nearly as scary as the news you're sort of being pummeled with. Going forward we'll continue to, as our CIO said, add value one point at a time to the mountain every single day. We will follow that research process and that's how we sort of achieve those long term objectives for our investors.

[00:17:31] Jordan Chevalier: That's fantastic, Ilan. I think that's a great place to leave it. Thank you again for coming and speaking to everyone here today.

[00:17:37] Ilan Kolet: Super. Thanks, Jordan.

[00:17:39] Jordan Chevalier: Thanks for watching The Upside. For more investor content visit Fidelity Canada's LinkedIn page and YouTube channel. Remember, working with a financial advisor is the best investment you can make on your financial journey. Thanks for watching. I'm Jordan Chevalier. I'll see you next time on The Upside.