The market landscape in Q2, 2023, and what we believe will unfold as a result:
Persistent inflation: More interest rate hikes than expected
Since the beginning of the year, Canadian and U.S. economic data has pointed to stubborn inflation resulting in market pricing in more interest rate hikes than expected.
Interest rates. On June 7, The Bank of Canada increased its target rate to 4.75% as it continued its policy of quantitative tightening. Inflation remains stubbornly high, and economic growth is weakening under the pressure of higher interest rates. Central banks warn interest rates may rise further to revive price stability. The Consumer Price Index (CPI) inflation reached 4.4% in April, with the prices for goods and services rising higher than expected. However, The Bank of Canada expects CPI inflation to rebound to 3.0% in the summer as they remain steadfast in their commitment to stabilizing prices for Canadians.
Equity markets have likely gotten ahead of themselves. While we maintain our positive outlook for equities in 2023, we believe the balance of risks in the near term may be downwards. Historically, there’s broad participation in sustained bull markets, and the recent reaction has seen only 20% of companies beating the S&P 500 Index. We believe that the equities markets have likely gotten ahead of themselves. With a backdrop of stubborn inflation, this could lead to more rate hikes rather than the beginning of rate cuts and the ever-looming risk of a recession.
So how do you best invest amid stubborn inflation? We believe that bonds provide a less risky opportunity relative to equities. The debt ceiling negotiations have resulted in yields increasing along the Treasury curve. The U.S. 10-year Treasury yield has risen by 40 basis points since the beginning of May, and we believe that an eventual resolution, combined with a weakening U.S. economy, could provide a ceiling for yields near these levels and potential upside for bonds should yields fall as the market begins to price in a recession.