The Federal Reserve held rates steady but says inflation is beginning to creep up and rates could rise later this year. Michael Craig, Senior Portfolio Manager, TD Asset Management, speaks to Kim Parlee about what rising rates in the U.S. could mean for your portfolio.
Hello. And welcome to the show. It's great to have you with us tonight. If you've been following the news today, the Federal Reserve did hold rates steady for now. But they do say inflation is beginning to creep up a little bit higher, and to expect gradual rises in rates to come.
With more on what rising interest rates could mean for currencies in your portfolio and the economy in general, Michael Craig. He is a Senior Portfolio Manager at TD Asset Management. That was a big promise there. You're just going to explain everything to us.
I'll just open with that. Let's just start with the Fed. Again, I don't think anyone was really expecting a move today, and we didn't get it. But we did hear some language about inflation moving closer to target. And I think the market's interpretation means, OK, that means more hikes are coming.
Yes. So there's certainly going to be more hikes this year. There will be likely a hike next month. They did introduce this word "symmetry" into their dialogue, which is really talking about trying to communicate to the market that, if inflation does go above their target, that it doesn't necessarily mean aggressively hawkish policy. But we are very close to their target now. And, therefore, we should expect many rate hikes in the months to come.
Many? Meaning-- are you looking two to three maybe in the next year.
Two more this year and a handful next year would be the kind of base case. However, if things start to really move and inflation really does crank up to 2.3%, 2.4%, then they're going to have to be more aggressive with their hiking.
Which we'll talk a bit about in terms of what you're seeing in the market. Let me ask you about the loonie. I know the last time you came on you had a more bearish look at the loonie. And I think-- even since that time, I think the loonie is down, what, $0.04 in three months?
So it's had a big move.
It's had a bit of a big move.
So when you see, again, prognostication that rates are going go up in the States, what's going to happen with the loonie from here on in?
I think the bank will keep up somewhat for a few, but I--
Well, one, maybe two, this year. I think our hiking cycle will be over by about Q1 of next year. There's not much farther I think the bank can go without creating a tremendous disturbance within our economy, particularly within the housing market. And so Poloz spoke yesterday in Yellowknife. He mentioned macro potential policy, other tools to cool the housing market.
So if he's going to use other tools to cool the housing market, there's going to be less reliance on higher interest rates to do it. So I think he is-- policies, is setting up for a lot of optionality. They don't want to be too dependent or don't want to telegraph too much what they're going to do, because they don't know what the data is going to look like. But I certainly think that he's setting up for less hikes than what the market actually expects.
Yeah. Different-- well, interesting. Also, just different data, different countries, right? I mean the Canadian economy looking quite different than the US economy, right?
The US economy is not dealing anywhere near the imbalances that the US economy-- so in 2007, big household problem in the US. That's gone. Household leverage is quite a bit lower. So the US doesn't have the problem. In Canada, household debt is very, very high. And so we have very much the similar characteristics as the US did in the mid-2000s. And so, therefore, you're going to have different paths and interest rate hikes.
Any other nice, happy news for us on that front? I was going to stay, I like hearing that here. It's a little scary. But anyway, let's talk about some charts. You brought in a few. And I want you to tell me why you brought these in and what's interesting. The first one we have here is we've got the US government five-year real yield. So bring this one up. Why is this chart interesting to you right now?
This is one of the most important things that I'm looking at right now. Real yield is taking government bonds and subtracting inflation. So it's the yield you receive after inflation. For much of the past decade, ever since the financial crisis, it's been negative. And that's been very accommodative for financial conditions.
If you're getting negative real interest rates after bonds, then you are forced into equities. And as a result, equities have rallied tremendously. We are now back to levels that we saw in 2010. As financial conditions tighten, this continues to move higher. It's off a tick, from the last month or so.
But this continues to really dominate the movement across financial assets. And this is where a lot of the turn we're seeing in bond and stock markets is the market's kind of reassessing where they should be based on this rate going higher. So this is very important. It's important for emerging markets, important for equities. And I think it will be very much important as far as how we go from here.
And the trend, I guess, what we are seeing, do expect that to continue to increase? That tick down, was that just a fall in inflation?
Yeah. You're going to have ebbs and--
--flows. But generally speaking, this continues to grind higher. And so it's very important to be mindful of this, because it's going to, I think, dominate the performance of most asset classes going forward, and currencies would be one of those. Typically speaking, when you see higher real interest rates in the US, you get a stronger US dollar.
Yeah. And inversely, the weaker Canadian dollar.
Weaker Canadian dollar.
You brought another one in here-- the US employment claims to labor force ratio. Now, this is-- again, we'll bring this one up. One thing I note that was circled in the chart that I've got right here is it's just really really really low.
So as far as high-frequency information goes, this data series is a weekly data series of US payroll claims and employment claims. And every time this starts to tick higher, you generally have a recession not so long afterwards.
But it's not now.
It is not now. But what's interesting is when you normalize this series-- so you got two lines here, an orange and a green one-- the orange one is the one that market looks at. The green one is actually normalized for the growth in the labor force. And so to put it another way, if we had 200 claims this week, it's much different than 200,000 claims 50 years ago.
Because the workforce is much larger. And we've never been this tight. The US labor market has never been this tight when looking at it on this metric since the data series started, call it, 60, 70 years ago. So very, very tight labor conditions. And again, this is a reason that you're seeing real rates rise higher and higher.
Got it. So, again, as these conditions are tight, you're going to see inflation increase, and that curve that we just had before is going to keep on moving up, right?
OK. US wage growth. Another one here, I guess, I think, talking to the tight labor market as well. Let's bring that one up. And it's showing again just wages are moving up.
Yeah. So this is the series which is actually kind of missing in action. Historically, we'd be seeing much higher wage growth at this part of the cycle than we've seen today. And I'd say this is the one element which is probably held back the Fed from being more hawkish. And so we're watching this very closely, because there's a fear that this actually starts to accelerate.
Many companies, in their quarterly earnings releases over the last few weeks, have mentioned tight labor markets, hard to find people, very difficult to find good hires. And so they haven't adjusted yet. They haven't actually raised wages. But, logically, that's the next step. If you can't find somebody at a certain price, you've got to raise the price higher. And, likely, that won't happen independently. Corporations will do that in unison. And that's what we're watching to see if this actually starts to accelerate, which would, again, lead to tighter financial conditions going forward.
So what does this all mean then, these three indicators? Tighter financial conditions, therefore-- what does it mean for different asset classes?
So we had a really smooth year last year. Markets just sailed. There was no volatility. Double digit returns, broadly speaking. This year, broadly speaking, negative returns; very, very choppy markets; bond markets still trying to assess where they should be. And so there's a lot of uncertainty. Now, this won't last forever. It will pass.
But it is one of those periods of time where, for our perspective, we've dialed back our risk. We've increased our cash. Cash isn't actually so horrible any more. It used to be you got zero. Now, we actually get around 2%. So not so terrible. Not great, but a place to hide out while we go through this volatility. Will it last forever? No. But it is a period of time where it is a little bit more challenging in these markets to generate returns.
I've got 10 seconds. If you are looking for returns, where are you looking right now?
So the best thing to do-- the backdrop of all this is if the dollar rallies, Canadian dollar will weaken. It's great to have assets outside of Canada. So the asset price might go down, but that will be offset by the stronger US dollar. That will be somewhat of an insulator to performance going forward.
Michael, always a pleasure. Thank you.
Thank you for having me.
Michael Craig, Senior Portfolio Manager with TD Asset Management.