I think we can all agree that the governments around the world overreacted to the pandemic with regards to the fiscal stimulus. Hindsight is a great thing because everything looks so obvious in the rear view mirror. There was free money everywhere and in many different forms, with the near zero interest rate policy being one of the most consequential forms.

 

One of the biggest problems that the Federal Reserve has faced is that lowering interest rates does not have an immediate impact on the economy. It usually take around 6-months to see the real effects of the stimulus. We call this a lagging indicator. This is now a problem but in reverse. The full effects of the rate hikes that the Federal Reserve is implementing now will only come to light sometime in the first quarter of 2023.

 

We know that the Federal Reserve would like inflation to go from 9% to its target 2% but who’s to say that inflation will stop at 2%. Why wouldn’t it go to 0% or maybe even into negative territory (deflation)? Inflation related derivatives on the swap market are implying that inflation will be back down to 2.5% by mid-2023. This is the same market that surged in the fall of 2021 and was a good 6-months ahead of the Federal Reserve so its track record is pretty good.

 

If this market is right then, bond yields have likely peaked, and it may be a good time to add bonds to the portfolios. Especially when you see how poorly the traditional 60% equities/40% bond portfolio has performed so far this year. 2002 is currently the worst year on record as illustrated by the chart below.

 

Source: Chair Powell, If You’re Out There, Read This, The Bespoke Report, Bespoke Investment Group, September 2022

 

With this in mind we are adding to our bond exposure in both allocation and duration.

 

I have also included two piece’s from our CIBC Economics Team entitled “Bank of Canada says were not there yet” and “The customer is not always right".

 

As always if you have any questions feel free to give us a call at any time.

 

Have a great weekend.

 

Milan