What can advisors take from a BoC hold with hawkish overtones?
Why the BoC took a hawkish tone against supply-side inflation
The primary drivers of inflation at this point in time appear to be energy prices connected to the conflict in the Middle East and the looming onset of retaliatory tariffs on US imports. Both of those forces are distinctly supply-side, meaning monetary policy’s capacity for demand destruction shouldn’t have much of an impact in curtailing that sort of inflation. Despite that, the BoC has offered somewhat hawkish messaging around inflation. Lin says that is likely a product of the persistent nature of inflation since the end of the COVID-19 pandemic.
People, including policymakers, tend to draw on their most recent experiences and view new stimuli in the context of past events and Lin believes that the BoC’s tone is informed by their multi-year battle with inflation. He adds that unlike the US Federal Reserve, the BoC technically has only one mandate: controlling for inflation. However, Lin says that this hawkishness should be viewed in the context of the BoC’s core goal: anchoring medium-term inflation expectations around two per cent. Monthly inflation spikes will factor less into the BoC’s approach than what that medium-term expectation rests at.
What to watch to see what happens next
The BoC’s approach, Lin says, will remain data dependent. Given how uncertain the state of the Canadian economy appears to be right now, with the impact of tariffs on both growth and inflation still unknown, leading indicators of economic health may be instructive. Lin says that consumer spending data can offer some immediate insight. He contrasts studies of the Canadian consumer with their US counterparts, noting that while both face higher energy prices, Canadians are pulling back on other spending in a way that Americans are not.
Lin says that if we see continued deterioration in the volume of goods Canadians are buying, even if nominal dollars spent increase, then it would be a sign of greater weakness among Canadians and a need by the Bank of Canada to provide additional support. The labour market, he says, will also be an instructive metric.
What Canadian fixed income investors can do now
The BoC decision comes amid a global increase in developed market bond yields. While global bond yields tend to demonstrate relatively high correlations over time, Lin argues that there are core differences in Canada’s fiscal situation that should continue to make its bond market attractive. Notably, Canada carries a far lower government debt burden as a per centage of GDP than other developed markets, especially the United States. Lin expects that Canadian bonds ought to rest at yields lower than their US equivalents, and that Canadian bonds should be looked at more favourably despite the large spread between Canadian and US yields we currently see
