The Bank of Canada hiked rates 75 bps to 3.25% this week, as widely expected. That brings the cumulative tightening so far this year to a whopping 300 bps, the fastest increase since the mid-1990s. The policy statement remained hawkish on inflation, despite growing evidence that we’ve seen peak prints (core inflation remains uncomfortably sticky and high). The Bank concluded that “the policy interest rate will need to rise further". But, they'll be "assessing how much higher interest rates need to go", presumably as the economy starts to weaken more significantly. We see another 50 bp rate hike at the next meeting in October. Unsurprisingly, rate-sensitive areas of the equity market have been slammed this year with REITs (to choose one example) down 20% in 2022, among the worst performers in the TSX.
Meantime, the ECB also raised rates by 75 bps, while last week’s solid jobs report and a still-hawkish chorus of Fed speakers led us to raise our call for Fed tightening. We now see a 75 bp move on September 21, followed by subsequent moves of 50 bps and 25 bps before year-end. Chair Powell said this week that “we need to act now, forthrightly, strongly, as we have been, and we need to keep at it until the job is done”. Long gone are the rate cuts that were recently priced in for 2023. For equities, the market continues to adjust valuations to this higher-rate world. The spread between the forward earnings yield on the S&P 500 and the 10-year Treasury yield has held relatively steady through this correction as the latter jumped. Real 10-year yields have also surged back into positive terrain in recent months, and the swing has been almost precisely matched by declines in the S&P 500 forward p/e ratio.