Traders work on the floor at the New York Stock Exchange in New York, on Aug. 10.Seth Wenig/The Associated Press
With interest rates rising, and rapidly so, the driving force that dictated decision making in financial markets for the past fifteen years is dying out. In a flash, disoriented investors have been exposed to a new world, one that demands dramatically different expectations for what constitutes a decent return.
Yet for all that’s changed, it can be tough to accept the era of ever-lower rates is truly over. Deep down there may be a tacit acknowledgment of changing winds, but it is often coupled with denial about what this all means.
The hope, it seems, is that the damage has already been done. Technology stocks have been clobbered, and house prices have finally started falling in Canada. But the undertow generated by rising rates is hard to contain, and for that reason it will likely ripple through financial markets, hitting everything from private equity to blue-chip stocks.
Such a sea change can be hard to grasp. Since the 2008-09 global financial crisis, investors of all stripes have grown accustomed to ever-falling interest rates. By July, 2020, the yield on the 10-year U.S. Treasury bond, a benchmark for financial markets, had dropped to a paltry 0.52 per cent.
The trend was so absurd, such a deviation from historical norms, that it even spawned a new mantra: “lower for longer.” Investors learned to accept that rates would stay low for longer than once thought imaginable – and it lasted for so long that it became the norm.
And now, in just seven months, it’s all changed, after scorching inflation and geopolitical earthquakes forced a paradigm shift. In July, the Bank of Canada raised its benchmark rate by a full percentage point, something not seen since 1998. The Federal Reserve hiked its own by 0.75 percentage points a few weeks later.
The reaction since has been quite bizarre. The Nasdaq Composite index for one, a barometer for growth stocks, is up 23 per cent from its June low. Investors seem to think the worst is behind us, and they’re happy to return to the way things were.
The reality: It is highly likely that there is no going back, at least not for quite some time.
“Many economists, strategists and investors are thinking the world hasn’t changed – that we’re in a normal cycle,” said Tom Galvin, chief investment officer at City National Rochdale, a subsidiary of Royal Bank of Canada with roughly US$50-billion in assets under management. He disagrees. “We are in a new era.”
This summer, Mr. Galvin put out a paper that spelled this all out, explaining why the new mantra must be ‘higher for longer.’
“Inflation will be higher for longer than we anticipated, interest rates will be higher for longer, geopolitical tensions and uncertainty will be higher for longer and high volatility in the economy and financial markets will be higher for longer,” he wrote.
Of course, Mr. Galvin is only one voice, and everything in economics and finance is so chaotic right now that it’s near impossible to call anything with 100 per cent certainty. In Canada, inflation is at its highest level in nearly 40 years, yet unemployment is at a record low. That isn’t supposed to happen.
But in the past two weeks a spate of Federal Reserve officials have given public interviews saying much the same.
The day after stock markets rallied this week on the back of news that month-over-month U.S. inflation was flat in July, Mary Daly, president of the San Francisco branch of the Federal Reserve, told the Financial Times that investors shouldn’t be so giddy. While the data was encouraging, core prices, a basket that strips out volatile items such as energy costs, still rose. “This is why we don’t want to declare victory on inflation coming down,” she said. “We’re not near done yet.”
Diane Swonk, chief economist at KPMG, can’t quite understand why investors are forgetting what scares the Fed the most: inflation. One of the central bank’s biggest failures in the past 50 years was allowing U.S. inflation to grow out of control – or ‘entrenched,’ in economics parlance – in the 1970s, forcing the Fed to eventually take drastic action to bring it back in line.
“This is a Fed that remembers the seventies,” Ms. Swonk said. “Most people operating in financial markets don’t.” Especially not the twenty- and thirty-something retail traders who sent stock markets soaring in 2021.
Fed officials can’t say outright they’ll tolerate a recession as a trade off for squashing inflation, but the eighties is proof they have and they will. “They’re going to raise rates and hold it for a while to grind inflation down,” Ms. Swonk predicts.
Despite the history, there is still speculation in certain corners of the financial markets that the Fed will change course. And there are some recent precedents of doing so. Twice over the past decade, the Fed and the Bank of Canada signalled they were ready to take action to cool the economy, but both times the central banks ultimately backed off. They did so first in 2013, after bond investors freaked out, and then again in 2019.
The big difference between now and then is inflation. Even Mike Novogratz, one of the most popular investors in cryptocurrencies, the mother of all speculative assets, warned in the spring that rates won’t be falling any time soon. “There is no cavalry coming to drive a V-shaped recovery,” he wrote in a letter to investors after the crypto market crashed, referencing the quick stock market rebound after the pandemic first hit. “The Fed can’t ‘save’ the market until inflation falls.”
Predicting precisely how financial markets will be impacted by higher rates is hard, but just like unprofitable technology stocks, the asset classes that benefitted the most from the low rate world are those most susceptible to tremors. Private equity and private credit, to name two, are near the top of the list.
When debt was ultra cheap, private equity funds could fund their buyouts for next to nothing. At the same time, passive investing was gathering steam, taking the shine off hedge funds and mutual funds. Private equity, then, became a vehicle for outsized returns.
Earlier this year, Harvard Business School professor Victoria Ivashina wrote a paper predicting a shake out in the sector, arguing that these tailwinds aren’t there anymore. “As the flow of funds into private equity stabilizes and as the industry growth slows down, the fee structure will compress and compensation will shift to be more contingent on performance,” she wrote.
Already there are signs that major investors are moving away from private equity. Earlier this month, John Graham, chief executive of Canada Pension Plan Investment Board, one of the world’s largest institutional investors, disclosed that CPPIB saw more value in public markets than private ones for now. And in a July report, Jefferies, an investment bank, wrote that major money managers, including pension and sovereign wealth funds, had sold US$33-billion worth of stakes in buyout and venture capitalfunds in the first half of the year, the most on record.
Private debt funds, which lend money to higher risk borrowers, are also vulnerable in the current environment. Money poured into the sector over the past five years because these investment vehicles tend to pay 8-per-cent yields, but that return looks much less rosy now that one-year guaranteed investment certificates pay nearly 4.5 per cent.
By no means are these asset classes dead in the water. The same goes with stocks and so many others. Rates have jumped, and quickly, but they are still low by historical standards.
However, there are many reasons why investors of all stripes should not be expecting a quick return to lower for longer. The latest inflation data is encouraging, but it’s a single data point. Who knows what type of energy crisis Europe and the United Kingdom will face this winter, and what that will do to oil and gas prices.
Inflation also isn’t known to disappear quickly. “It’s easy to get from 6-per-cent core inflation to 4 per cent,” Ms. Swonk, the economist, said. “It’s really hard to get from 4 per cent to 2 per cent.”
Human Resources Officers must be very busy these days what with the general turnover of employees in our retail and business sectors. It is hard enough to find skilled people let alone potential employees willing to be trained. Then after the training, a few weeks go by then they come to you and ask for a raise. You refuse as there simply is no excess money in the budget and away they fly to wherever they come from, trained but not willing to put in the time to achieve that wanted raise.
I have had potentials come in and we give them a test to see if they do indeed know how to weld, polish or work with wood. 2-10 we hire, and one of those is gone in a week or two. Ask that they want overtime, and their laughter leaving the building is loud and unsettling. Housing starts are doing well but way behind because those trades needed to finish a project simply don’t come to the site, with delay after delay. Some people’s attitudes are just too funny. A recent graduate from a Ivy League university came in for an interview. The position was mid-management potential, but when we told them a three month period was needed and then they would make the big bucks they disappeared as fast as they arrived.
Government agencies are really no help, sending us people unsuited or unwilling to carry out the jobs we offer. Handing money over to staffing firms whose referrals are weak and ineffectual. Perhaps with the Fall and Winter upon us, these folks will have to find work and stop playing on the golf course or cottaging away. Tried to hire new arrivals in Canada but it is truly difficult to find someone who has a real identity card and is approved to live and work here. Who do we hire? Several years ago my father’s firm was rocking and rolling with all sorts of work. It was a summer day when the immigration officers arrived and 30+ employees hit the bricks almost immediately. The investigation that followed had threats of fines thrown at us by the officials. Good thing we kept excellent records, photos and digital copies. We had to prove the illegal documents given to us were as good as the real McCoy.
Restauranteurs, builders, manufacturers, finishers, trades-based firms, and warehousing are all suspect in hiring illegals, yet that becomes secondary as Toronto increases its minimum wage again bringing our payroll up another $120,000. Survival in Canada’s financial and business sectors is questionable for many. Good luck Chuck!. at least your carbon tax refund check should be arriving soon.
NORMAN WELLS, N.W.T. – Imperial Oil says it will temporarily reduce its fuel prices in a Northwest Territories community that has seen costs skyrocket due to low water on the Mackenzie River forcing the cancellation of the summer barge resupply season.
Imperial says in a Facebook post it will cut the air transportation portion that’s included in its wholesale price in Norman Wells for diesel fuel, or heating oil, from $3.38 per litre to $1.69 per litre, starting Tuesday.
The air transportation increase, it further states, will be implemented over a longer period.
It says Imperial is closely monitoring how much fuel needs to be airlifted to the Norman Wells area to prevent runouts until the winter road season begins and supplies can be replenished.
Gasoline and heating fuel prices approached $5 a litre at the start of this month.
Norman Wells’ town council declared a local emergency on humanitarian grounds last week as some of its 700 residents said they were facing monthly fuel bills coming to more than $5,000.
“The wholesale price increase that Imperial has applied is strictly to cover the air transportation costs. There is no Imperial profit margin included on the wholesale price. Imperial does not set prices at the retail level,” Imperial’s statement on Monday said.
The statement further said Imperial is working closely with the Northwest Territories government on ways to help residents in the near term.
“Imperial Oil’s decision to lower the price of home heating fuel offers immediate relief to residents facing financial pressures. This step reflects a swift response by Imperial Oil to discussions with the GNWT and will help ease short-term financial burdens on residents,” Caroline Wawzonek, Deputy Premier and Minister of Finance and Infrastructure, said in a news release Monday.
Wawzonek also noted the Territories government has supported the community with implementation of a fund supporting businesses and communities impacted by barge cancellations. She said there have also been increases to the Senior Home Heating Subsidy in Norman Wells, and continued support for heating costs for eligible Income Assistance recipients.
Additionally, she said the government has donated $150,000 to the Norman Wells food bank.
In its declaration of a state of emergency, the town said the mayor and council recognized the recent hike in fuel prices has strained household budgets, raised transportation costs, and affected local businesses.
It added that for the next three months, water and sewer service fees will be waived for all residents and businesses.
This report by The Canadian Press was first published Oct. 21, 2024.
TORONTO – A new report says many Canadian business leaders are worried about economic uncertainties related to the looming U.S. election.
The survey by KPMG in Canada of 735 small- and medium-sized businesses says 87 per cent fear the Canadian economy could become “collateral damage” from American protectionist policies that lead to less favourable trade deals and increased tariffs
It says that due to those concerns, 85 per cent of business leaders in Canada polled are reviewing their business strategies to prepare for a change in leadership.
The concerns are primarily being felt by larger Canadian companies and sectors that are highly integrated with the U.S. economy, such as manufacturing, automotive, transportation and warehousing, energy and natural resources, as well as technology, media and telecommunications.
Shaira Nanji, a KPMG Law partner in its tax practice, says the prospect of further changes to economic and trade policies in the U.S. means some Canadian firms will need to look for ways to mitigate added costs and take advantage of potential trade relief provisions to remain competitive.
Both presidential candidates have campaigned on protectionist policies that could cause uncertainty for Canadian trade, and whoever takes the White House will be in charge during the review of the United States-Mexico-Canada Agreement in 2026.
This report by The Canadian Press was first published Oct. 22, 2024.
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