Transcript: Has the Fed lost the plot?

Dustin Reid (DR): I think inflation has become structural, particularly on the core side. So, in ’21 we liked the term “level up,” i.e., inflation was going to be running at a higher level for a while. Then we kind of migrated from “level up” to “sticky,” which I think it’s obvious what it means. And then “sticky” to “structural,” i.e., structural’s a little more ingrained. And I think we’re there. The way the Fed looks at it, which I think is not a bad way to do it, is what I would call “core services ex shelter.” And that’s kind of the hot line within CPI of how the Fed looks at it. Technically, the Fed is targeting core PCE and here domestically, in Canada, the CPI is a little bit more of a focus, as opposed to a PCE metric. But regardless of how you look at it, I think it is going to be very difficult to get to 2% this year.

The outlook for the Bank of Canada.

DS: A lot of central banks were caught off guard by the non-transitory nature of inflation. I don’t think the bank here was any different. We’re a much more high-beta economy than the U.S. And that’s just a fancy way of saying we’re much more sensitive to interest rates. And, you know, why is that? The U.S. household really delevered after ’07, ’08, ’09, and the Canadian household did not. We’ve all seen these numbers and these charts, but the Canadian household is very, very levered up, particularly because of the mortgage story. So, the Bank of Canada is very aware of that and, has been trying to manage that. So, I think the bank here did an admiral job. But I think the bank wants to be done. The operative word being ‘wants.’ The bank is probably on hold here for a bit. The market is actually pricing in some rate easing relatively soon, maybe even before the second half of the year But, barring some sort of financial industry negative event, I think that the bank will be on hold at least through the summer, into Q3 and maybe beyond.

The threat of recession.

DR: You can clearly see three camps: people expecting a hard landing, expecting a soft landing, and expecting — this is kind of the new mantra — a no landing. It was interesting, with the most recent Fed meeting, when someone asked Chair Powell, “Do you still expect a soft landing?” And Powell, for the first time in this cycle, I thought, really sidestepped the question. So, I think it’s interesting when the Fed thinks that they may have lost the plot a little bit, on what they were trying to engineer. And this idea that in the forecast, the Fed is effectively expecting 0% growth for the rest of the year, in Q2, Q3, Q4, given that Q1 is running at 3% and they basically only expect 0.4% real growth for 2023, that would suggest that the Fed thinks that growth is going to slow materially. And that would not be a soft landing, in my opinion.

The current condition of money supply

DR: We’re not seeing a crunch yet, although it’s very early after this potential credit shock. But we have seen the money supply slow over the last little bit, back towards more normal levels. That pace that we were running on two-and-a-half years ago, that needed to slow because otherwise this would be a very, very different inflationary picture that we’d be dealing with.

Opportunities in duration

DR: When the volatility is low you can kind of lengthen out your trade horizons. When the volatility is extremely high, it’s generally prudent from a risk management and portfolio management perspective to shorten that length and be a little bit more tactical and nimble. That all said, we are shorter duration than the benchmark, and we generally like steepener trades — so kind of 5s-30s, or 10s-30s, or 2s-10s steepeners — in that environment.

And finally, what should financial advisors keep in mind?

DR: Inflation is probably going to remain a little bit sticky and structural. And that makes fixed income really interesting in the global macro environment, both from an economic and a trading perspective for ’23 and going into ’24, and beyond. How I would leave it is, be prepared to be nimble. Be prepared to look at a lot of information. Listen to what people in government are saying and how policy may evolve going forward. And don’t necessarily be married to a view that you just think has to be fundamentally true. The news flow and market sentiment and positioning can change very, very quickly. That’s the prudent way for investors to look at it, as we move through this very, very uncertain but very, very interesting era here over the next few quarters.

Well, those are today’s Soundbites, brought you by Investment Executive and powered by Canada Life. Our thanks again to Dustin Reid of Mackenzie Investments.

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