The second big rate cut of 2024 by the Bank of Canada was a decisive one, weighing in at 50 basis points and cutting the key interest rate to 3.75 per cent. The last time the country saw interest rate cuts of this magnitude was in March 2020, when the BoC lowered the key rate by 50 basis points three times within the same month as a response to pandemic-era financial conditions.
The positive take on this week’s dramatic lowering of the benchmark rate is that it’s a sign of a job well done in the BoC’s efforts to bring inflation down to target levels. Yet some observers see a less rosy picture—of an emergency jolt to support a flagging domestic economy, marked by troublesome employment numbers despite three previous cuts totalling 75 basis points.
While the cumulative effect of the rate cuts will take some time to percolate through the economy, experts differ on what the BoC’s monetary easing will mean and what economic conditions will look like on the other side for high-net-worth investors.
Has the Bank of Canada hit the mark on inflation and the economy?
Dave Makarchuk, chief investment officer with WealthCo, a Calgary-based wealth management firm, believes the October cut hits a sweet spot between a successful battle against inflation and a need to bolster the Canadian economy.
He says he is not concerned that the cuts will reignite inflation, because short-term rates remain high relative to rates over the last decade. Even if this cut is not large enough to stem a mild recession, that’s OK, too, Makarchuk adds.
“The Canadian economy isn’t that strong right now,” he says. “But a mild recession is not the end of the world—it’s a normal and healthy part of an economic cycle. A soft recession is probably the best way to reorganize the economy and get on with economic growth. A Goldilocks scenario is still the goal, and it’s still plausible.”
On the other hand, the size of the cut is historically significant, says Paul de Sousa, head of wealth management, sales and development with Sightline Wealth Management, an independent wealth management firm specializing in alternative investment strategies.
“The last time that there was an emergency cut of 50 basis points was when we were in the global financial crisis in 2020,” he says. “It appears the Bank of Canada is now quite worried about a recession and they’re looking at the unemployment rate, which has been rising since Jan. 1, despite a marginal reversal in September.”
Unemployment hit 6.6 per cent in August, rising from 5.7 per cent in January and easing only slightly to 6.5 per cent in September.
Has inflation been tamed?
The Bank of Canada notes that the economy experienced a 1.6 per cent year-over-year inflation rate in September, down from 2.0 per cent in August. That seems to signal that it has achieved its goal of returning the country to two per cent annual inflation. So, mission accomplished?
Not exactly, de Sousa says. Despite the headline inflation numbers, consumers on the ground say they continue to face price pressure on categories such as rent, insurance, food, property tax and utility payments, even as they attempt to normalize the price increases that they’ve already experienced. De Sousa is also not convinced that inflation is ready to lay down and die.
“There’s an upper limit on central bank rates when governments have taken on so much debt they can’t finance interest payments,” he says. “And yet, reducing the interest rate and reinvigorating the economy is likely to revive inflationary pressure. The Bank of Canada is treading a narrow path to low inflation, low unemployment and at least average economic growth—and I’m not confident that a soft landing will occur.”
What does it mean for the stock market?
Makarchuk sees an upside for the broader stock market, which he believes has the chops to weather a mild recession. However, he thinks small caps have the greatest upside potential.
“The Magnificent Seven stocks have been a huge part of the growth over the last 12 months or so, but they’re crazy expensive,” he says. “On the other hand, when you look at the price and earnings multiples of everything else compared to the historical stock market, they’re not that expensive. The average small cap company is a bit more leveraged than large cap, and they have a higher interest expense, so I think they’ll benefit most from rate cuts.”
De Sousa also sees an upside for the stock market, which has proven extremely responsive to rate cuts. He looks to sectors that thrive in lower interest rate environments, especially capital-intensive industries such as utilities, commodities and real estate.
The stock/bond seesaw, or something more stable?
Investors who were driven out of the fixed income market by rapidly escalating interest rate increases have experienced more favourable conditions over the past 12 months.
But de Sousa says that the flipside of stock market gains could be a downside for bonds, with increased reinvestment risk for bondholders as yields fall.
Makarchuk, however, notes that bonds have been strong over the past year. In fact, from Oct. 23, 2023, through Oct. 23, 2024, the iShares Core Canadian Universe Bond Index ETF, which closely tracks the FTSE Canada Universe Bond Index, rose 10.48%. Now, he believes bonds will offer more modest opportunities to investors.
“Bonds didn’t protect capital when rates went up rapidly, but going forward we think they’re a good source of capital preservation with an upside from yields falling further,” he says. “It’s really hard to imagine rates rocketing up again, and three-and-a-half to four per cent is fine as long as you accept bonds for what they are.”
Is now the time to sell off assets?
For wealthy families considering the liquidation of assets, de Sousa sees a mixed bag in terms of selling opportunities. Lower interest rates and cheaper credit may herald a good opportunity to sell a business or real estate assets, with property prices likely to rise.
“But if this jumbo rate cut fails to stem a recession, we may also see lower demand for these assets and lower vacancy rates in commercial properties, depressing those prices,” he says.
Makarchuk believes that selling off U.S. dollar holdings makes a lot of sense for wealthy families looking for liquidity following the rate cut.
“Canada has been more aggressive than the U.S. on rate cuts, and as a result the Canadian dollar has struggled, with the U.S. exchange rate at $1.38 today,” he says. “It’s really hard to see the U.S. dollar going over $1.40. The U.S. will catch up to Canada eventually on rate cuts, and eventually the U.S. dollar will fall.”
More cuts to come?
The markets are betting on at least one more rate cut by the BoC in December of either 25 or 50 basis points as a final gift to top off the year.
Both de Sousa and Makarchuk agree that more rate cuts are probably on the horizon.
Makarchuk believes the cuts will be largely coupled to similar ones from the U.S. Federal Reserve. De Sousa thinks the BoC may be considering going big a second time, with another 50 basis point cut in December.
Whichever direction the Bank of Canada follows, both see it treading a narrow path as it carefully watches unemployment and inflation figures and any rate cuts by the U.S. Federal Reserve.
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