After the most recent Bank of Canada rate hike there has been a whole lot of talk about rate hikes, normalization and how Canada’s central bank will pursue its monetary policy. If the sign of intelligence is what one does when he knows not what to do, the next 18 months will test every central banker including the BoC’s.  In a nutshell here is what is happening:

The yield curve which has been the best predictor of recessions for the past 50 years is reaching dangerously low levels.  This is only one of many signs that a recession is on the horizon and it looks like 2020 will be the year it arrives.

In a few months the current economic expansion following the previous recession will be the longest ever recorded.  It may in fact become the longest but is was certainly not the strongest.  GDP accumulation in this cycle has been weak and this may indicate that the expansion will continue through 2019 as nothing is killing it, the wage mechanism is simply not working.  The ability of the global economic market of developed nations to grow is now limited. This is due to limited demographic growth as the population is getting older and older.

The global commodity market is showing signs of slowdown except for the US due to tax cuts and government stimulus that is artificially inflating GDP at the behest of deficit and debt.

It is a strong possibility that in 2020 the FED (the US equivalent of our BoC) will have to cut interest rates. This is mainly due to the fact that the central banks were chasing inflation concerns that did not exist.  But inflation is a lagging indicator, like a brown spot on a banana: when it appears its already too late. This is also a good explanation why US stocks are showing nervousness.

We mentioned above that the wage mechanism is broken and this merits additional discussion as it is the cause of major issues. Why is it broken? The aging population is a large factor.  The fastest growing segment of the labor market is 55 and older and this should be a major concern.  Contrary to other demographics, the 55 and older crowd behave differently.  They are willing to work but work less.  They are also less prone to ask for a wage increase compared to the 20 - 40 age group. 
The number one factor of wage stagnation however is the mismatch in the labor market.  We have people that have jobs and jobs that don’t have people.  This is true for the US, Canada and the Euro zone. In fact, in the US today, the segment of people collecting some form of social insurance is greater than any other demographic segment collecting wages.  They gave up looking for employment!  This is their cry and Trump is their messenger.

In Canada the widening income gap is in our opinion the greatest concern. Even though Canada is one of the most educated population we are not converting degree’s into jobs.  This is a failure to our younger generations.  Education must be rethought; the system is clearly not working. Since education is the key issue in order to find a job and therefore access property and wealth, policies need to be developed to address this and quickly.

Now let’s talk China.  250 million young Chinese are the key to consumer growth which will be most important in emerging markets.  The US trade war with China is a major threat to economic growth and prosperity.  Not only is the current path unwise since China deliberately manipulates currency rendering tariffs useless and enabling China to take the long approach and weather the storm.  The inverse however is not necessarily true and the US China commercial conflict may prove disastrous should the economy come to a halt in 2020.

What does all this mean for interest rates in Canada? It comes down to the question of inflation or growth?  Everything the BoC does seems to be taking a dollar approach.  Currency is a major concern and the current central banker of the BoC seems to have an agenda.  If in fact the agenda is growth this will limit interest hikes in the future by the BoC because of the US tax cuts which are forcing more investment into the US. A stronger dollar coupled with a less interesting tax haven could be catastrophic for the Canadian economy.  Interest rates will certainly rise in the short term but one should be less panicked than the media coverage would lead you to believe.  The sensitivity of Canadians to interest rates is substantial and the BoC will think twice before pursuing an aggressive normalization policy.  The disease is sometimes the cure as they say, and therefore the increased sensitivity to high rates will prevent interest rates from rising rapidly moving forward.  They will increase but slower than the hype that we are seeing right now until the next recession hits and we start all over once again.

After the last recession, after the great recovery, after the US election, clearly what was ‘’normal’’ in the past is no longer ‘’normal’’ today.  The way we look at the economy, growth, wages and education must be different moving forward. As we continue to learn and collect information we will continue to provide all our clients as much insight as possible as we believe very strongly that an educated client is better off even when the information is not always positive.

Ryan La Haye

*the insights in this article were collected via the opinion of various economists notably Benjamin Tal and data collected from various Think Tanks and Statistics Canada*

**the information in this article should not be seen as favoring one type of mortgage versus another but simply information for a client to make a more informed decision in regards to his personal needs and risk tolerance**