With inflation sitting at multi-decade highs, there’s increasing hope that price pressures may be peaking. Greg Bonnell speaks with Scott Colbourne, Managing Director, Active Fixed Income, TD Asset Management, about why peak inflation may not spell immediate relief for financial markets.
Central banks have been delivering supersized hikes in an attempt to control rising costs. And while you can make the argument that inflation has possibly peaked, our feature guest today says higher consumer prices aren't going away any time soon. Joining us now is Scott Colburn, Managing Director of Active Fixed Income at TD Asset Management. Scott, great to have you back on the program. Inflation is all anybody can talk about. And of course, there's always that hope that perhaps inflation has peaked. But you say, well, don't get too excited, even if it peaks and starts to come down. We're going to be dealing with this for a while.
Yeah. I mean, I think you can find some positive news and I'll start with a little bit of positive news on the inflation side. We certainly have seen some moderation on supply chains. So that's taking the edge off a little bit. And inflation expectations in the market have stabilized. They're actually back to levels where we saw sort of mid-summer. So there's some good news. And commodity prices are off their peaks as well. So, you know, there's evidence leading to focus that we've likely peaked on headline inflation. But I think the challenge for investors as well as policymakers is what do you do with the core? It's off its peak level, but it's sticky. You're talking about wages. You're talking about shelter, health care. These are things that are not just subject to the big ups and downs of demand. And so those are sticky and those are going to be a bit persistent. And that's going to be the big question for central banks and investors as we go along and we see headline inflation coming down, but the core being a little bit more sticky and as a fixed income investor, that's what we were trying to get our head around in terms of next year and the balance of this year.
Is there much the central banks can do about that stickiness? At the core, it's one thing to aggressively raise rates like they have. And perhaps you start, we're seeing in the housing market, some of the demand backs off a bit, wait a minute, the game is changing, need to figure out where we're headed here. But as far as that core stickiness, wages, other places, the central bank will have much power there?
No. I think at the end of the day, there's a limits to what you can do as a as a policymaker. They really obviously can't address the supply side, that we'll address over time as we sort things out. They have to deal with the demand side, you know, the tight labor market, the wage pressures and stuff like that. And so we've seen the response. We had the Bank of Canada do 100 basis points. We're going to get 75 from the Fed. Those are all things, that's the best they can do and they'll continue to push it. And we're going to see slower growth. And over time that will feed into shelter, it will feed into wages. We will see some adjustment. We're seeing some of the higher frequency data slow down for sure. But it's going to take a while, but central banks are playing catch up here. They they were slow to react and slow to deal with the changing dynamic of inflation. So, you know, they've still got some ways to go before they finish the tightening cycle here.
You mentioned the expectation for the Fed next week is 75. I think it was a brief period where they thought maybe, hey, or they might they I mean, the market and all the participants, maybe they got 100 just like the Bank of Canada did. Is there a rationale in terms of what we're seeing, in terms of some of the data that the Fed will be watching, I don't think we need to go quite as hard as the BoC, just went.
It's a fine line. We went from 50 is the new 25 and now the 100 is the new 50. I think that the Fed did 75, they'll do 75 again. They there was a little bit of pushback from some of the central bank governors, the regional ones that just don't want to push the limit too far here. And so, will the terminal rate of where the market thinks that both Bank of Canada and the Fed will get to sort of by the end of this year and early next year has been pretty steady. It's around 3.5, 3.75%. So I think the Fed just wants to keep moving steadily above that neutral level that it has targeted for.
I guess as humans, we like to look forward and look for any relief on the horizon. It is interesting that there's parts of the market pricing in, even though we're not even done with the rate hiking cycle, that don't worry. And then sooner rather than later, you're going to see cutting again. I mean, is that a bit too much optimism? The central banks keep riding to the rescue. Riding to the rescue. But I've heard a lot of people sitting in that chair and probably you the last time you were on saying, can't expect them to ride the rescue forever.
Yeah, there's sort of a sense that they'll overshoot and really slow things down. And there's a possibility, lots of talk of recession. And then the market's natural inclination is to price in cuts. And in fact, next year they've priced in two cuts by the Fed. I don't think they're going to get there. I start back where we started off this conversation about sticky inflation. I think it's going to be a headwind for them. And one of the issues that investors are really going to have to get their heads around is, as we see slower growth and inflation, but core inflation remains sticky, is what are the policy levers that governments and monetary policy officials have as we potentially enter into a slow growth recessionary environment? And given the sticky inflation, the envelope is reduced actually in terms of what they can do. So I'm not a big believer that they're going to be cutting, but that's what's priced into the market at the moment.
Is the term stagflation, which got thrown around and there's probably some people still throwing it around. Does it have any bearing on our forecast for the next little while, or is that just too dire a prediction? You cannot tame prices. You can't bring them down but the economy is not doing us any favors either.
Yeah, there's lots of focus on what is stagflation. Is it a recession? There's different flavors, different issues around the globe. Canada has its own Achilles heel in the housing market. In Europe we're dealing with the conflict as well as the Nord Stream gas and how much is going to be coming into Europe during the winter. And then in China, we've got basically flat growth and zero COVID policy. And so if you want to, you can really drill down into various parts of the globe in terms of what this will look like. Certainly, Europe and Asia don't have the same inflationary pressures that we have in North America. And so it's going to be different around the world. And I think that's moving away from the sort of those labels, if you will, for investing purposes. Digging down into what it means regionally is really more the important thing for the balance of the year into next year.
Is that where we get the clarity from? I'm just thinking in terms of... I start the show by showing the audience a nice market rally. I have no idea what's going to happen tomorrow based on the same conditions that we continue to live through. And I thought, at the back of my mind, why don't I get some clarity about what's happening in the world? Or am I just being overly optimistic on that point that I'll ever get sort of an idea?
Yeah, we really want that clarity. What we used to have is a pretty low inflationary, low growth environment where central bankers were always able to give us the put and we just don't have it anymore. We have so much uncertainty and some of it that's geopolitical. It's just out of the realm of policymakers. Maybe if there's some resolution on the conflict or there is some element of relief on commodity side, we'll get a little bit more clarity, but it's a very difficult environment that we're operating in with labor shortages, tight labor market, high supply chain challenges globally. It's not going to pop up around the corner any time soon.