Inflation drives interest rates. Interest rates drive everything else.

So what could cause interest rates to decline?

Lower inflation… specifically inflation below a year over year rate of 2%.

The Bank of Canada’s target inflation rate is 2%.

Look at the chart above and you’ll see that the rate of increase in inflation has significantly dropped since July 2022.

To be clear, in mathematical terms, I’m referring to the rate of change of the rate of change… a second derivative, or what acceleration is to distance (km/h/h)

If we look at the two time periods:

  1. January 2022 to July 2022
  2. July 2022 to February 2023

The first period from January 2022 to July 2022 had an annualized inflation rate of 8.17%.

The second period from July 2022 to February 2023, after four months of interest rate increases, have seen the annualized inflation rate slow to 2.2%.

Up until last month, the annualized inflation rate from July 2022 to January 2023 was even lower at 1.62%.

Take an average of the previous two months and you get 1.8%

We believe that inflation will continue its slow upward trend as more and more households see renewal rates much higher than they previously enjoyed.

While we see supply issues in the market still, we believe that lower household cash flow will overpower the desire or ability to replace aging products and pay for services.

Should the inflation rate drop below 2%, the Bank of Canada will be forced to decrease its overnight rate.

We believe that the Bank has overshot their inflation reduction goals and will ultimately need to lower interest rates.

During the April 12, 2023 Bank of Canada Press conference, the governor stated that they expect inflation to reach 3% by summer and it will take some time, potentially until the end of the year, to get back down to 2%.

The market doesn’t believe this and neither do I.

Can we have lower inflation without a worse off economy?

Only time will tell.

Base Expectations: Return to normal

  • Inflation falls below 2% in the second half of the year
  • Interest rates drop
  • Stocks rise with a lower discount rate
  • Bonds rise with lower interest rates
  • The economy slows but doesn’t suffer materially

Downside Risk Management Scenario: BoC Overshoots

  • The Bank of Canada waits too long to moderate interest rates
  • Waiting until 2% inflation is present
  • Interest rates stay the same or slightly increase
  • The economy suffers
  • Stocks sell off on poor economic data
  • Bonds rise with lower interest rates

In either case, we are focused on dividend stocks, away from the financial sector.

Bonds are being split between mid duration, high quality bonds and high interest savings that are currently yielding over 4% on an annual basis.

Want to know more about our approach to portfolio management as it relates to retirement and financial planning?

Reach out today!

Until next time,

Trevor

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Trevor Dale, CFA

CEO, TK Dale Wealth Inc.

Portfolio Manager, TK Dale Wealth Management Inc.

Life Insurance Agent, TK Dale Wealth Insurance Inc.

Mortgage Broker, TK Dale Wealth Mortgages Inc. Lic. #13359

#7-17075 Leslie St.,  Newmarket, ON L3Y 8E1

*Disclaimer: Please note that this communication contains forward looking information. We do not guarantee or warrant these statements and cannot guarantee that the outcomes will occur. This is not individual advice and you should seek the help of a licensed professional. This is not intended to solicit residents outside of Ontario, Canada. We do not provide tax or legal advice. Securities mentioned in this communication are not recommendations. We do not endorse nor recommend any securities mentioned. This is not financial advice. We recommend seeking the help of a licensed professional prior to making investment and financial decisions.