Are Bank of Canada rate hikes sunsetting soon? Economists and commentators wonder, as the central bank’s inaugural 2023 meeting nears.
The easing in the inflation rate in December is being seen as a sign the central bank’s tightening cycle may end soon – with many predicting a final 25-basis-point hike this week. (A basis point is 1/100th of a percentage point.)
But whether the bank raises rates more or less, sooner or later, investors needn’t fret its decisions.
With their piles of PhDs, the thinking goes, central bankers must be wiser than the collective marketplace – with superhuman forecasting powers and the skills to steer Canada’s economy, if needed. Hence, many presume, Bank of Canada talk is prescriptive and its policy moves are critically important. Nope.
I have long written that central banks are more reactor than causer – economic and market conditions drive their decisions, not the reverse. Why? Widely held economic expectations – like inflation driving up long rates – are largely, if not completely, prepriced. Plus, with so many similarly trained economists on staff, central bankers’ talk and forecasts rarely deviate from consensus views.
Central-bank jawboning doesn’t prevent surprises and volatility. It often creates them, when decisions or forecasts differ from preset expectations. Consider “forward guidance” – the central bank’s telegraphing of coming policy moves.
Sure, the bank has “officially” used forward guidance only twice – allegedly to counter the economic threats of COVID-19 and the global financial crisis. But unofficially? Nonstop. Consider 2022: Last January, the Bank of Canada announced it was ending “exceptional forward guidance” amid waning COVID-19 fears. Yet in May, it began “interest rate guidance” – while claiming the new policy wasn’t forward guidance. By flip-flopping and babbling nonsensically, the central bank confounds investors and draws the public’s ire.
Hot inflation in late 2021 and 2022 exposed the Canadian bank’s forward-guidance flaws. The bank, like many of the world’s central banks in late 2021, said soaring inflation was fleeting. Its policy statement in October, 2021, projected inflation would ease to 2 per cent by “the middle quarters of 2022″ as energy and supply bottlenecks eased. It “committed” to keeping rates near zero until that happened and the economy absorbed its remaining slack.
So much for that. By January, 2022, it dropped the commitment, declaring the economy slack-free – teeing up the rate-hike fears partly underpinning the Toronto Stock Exchange’s mid-2022 plunge. Those increases started in March, 2022, continuing at every meeting since. Target rates ended 2022 at 4.25 per cent and headline inflation at 6.5 per cent year-over-year. If the Bank of Canada doesn’t know what it will do next, how can you?
Many parse bank officials’ words, searching for clues on what it will do next. Some fret Governor Tiff Macklem’s December speech – when he professed to preferring the bank hike rates too much rather than too little – as a sign that increases could run much higher for longer. But why believe it? The bank decides rates by committee. Each member has their own biases, opinions and interpretations of the latest data. People are too fickle and unpredictable to handicap how any policy maker cabal will act.
It isn’t just the Bank of Canada. Global central banks are uniformly fickle and feckless. Some examples? In May, 2022, the U.S. Federal Reserve said it wasn’t even considering hiking in 75-basis-point increments. It then hiked that much in June and each of its next three meetings.
In Britain, numerous U-turns crushed former Bank of England boss Mark Carney’s credibility in 2014 – he was publicly compared to an “unreliable boyfriend.” His successor, Andrew Bailey, got the same nickname in 2021 after reversing course on expected hikes. Some interpreted the Bank of Japan’s December yield curve control pivot as a shift to more conventional policy decisions ahead. That primed markets for confusion when the Japanese bank didn’t budge in January.
But don’t central bank actions guide the global economy? No. The 2022 Bank of Canada and Fed rate hikes prove this.
Hikes normally impair growth by raising banks’ short-term funding costs, theoretically cooling lending and impaling the economy. Banks borrow short-term funds to finance longer-term loans. But, as I detailed in November, banks are currently flooded with near zero-cost deposits. They needn’t borrow otherwise or compete for more with higher rates.
In Canada, deposits’ share of chartered bank liabilities is historically high, while personal chequable deposits are about 47 per cent above pre-COVID levels (as of October, 2022, the latest data available). Cheap funding renders lending more profitable. Hence, it accelerated throughout 2022 despite four percentage points of increases. The same holds in America.
Investors needn’t fixate on the Bank of Canada – whether it hikes higher for longer or pauses entirely. Shift your focus to the robust quantity of actual lending, falling input prices and lower inflation expectations, which already have Canadian longer-duration bond yields well off their highs. That – alongside widespread recession anticipation mitigating economic negatives – is stock-market recovery fuel.
Ken Fisher is founder, executive chairman and co-chief investment officer of Fisher Investments.