Loonie sees selling pressure
While it came as no surprise to the financial markets, the move by the U.S. Federal Reserve to hike interest rates refocused attention on the widening divide between U.S. and Canadian monetary policy. The addition of 25 basis points (a basis point is 1/100th of one per cent) to the federal funds rate at the December meeting brings the total to 125 since the end of the global financial crisis in 2008-09. Conversely, over the same period, the Bank of Canada raised rates three times in 2010, cut rates twice in 2015 and tightened twice in 2017. The net effect has been 75 basis points of tightening. Not surprisingly, as the bank has stated that its approach going forward will be cautious, the Canadian dollar has come under selling pressure. The loonie, which traded as high as US$0.825 in early September, has fallen nearly five cents to break below US$0.776 on December 12. With the U.S. forecast to outperform the domestic economy and a greater tightening bias stateside, a material strengthening of the Canadian dollar appears unlikely at this juncture.

U.S. Federal Reserve hikes rates again
For the third time in 2017 and for a fifth time since the end of the financial crisis, the U.S. Federal Reserve Board raised administered interest rates at the conclusion of its two-day policy meeting. The mid-point range for federal funds now stands at 1.375%. While this is the highest rate since October 28, 2008, it remains well below the previous cyclical peak of 5.25%. Coinciding with the announcement, the Fed released its updated economic forecast. Projections for U.S. economic growth have been revised higher with GDP growth expected to be 2.5% for 2017, 2.5% in 2018, 2.1% in 2019 and 2% in 2020. 2018 saw the largest upward revision (+0.4%) while other years were +0.1% or 0.2%. More importantly for the financial markets, the Fed is projecting three further interest rate hikes in 2018.

U.K. inflation ticks higher
The U.K. Office for National Statistics announced that the consumer price index rose 3.1% year-over-year in November, up from the 3% level seen in October and is the fastest inflation pace since March 2012. Most of the gain was attributed to rising prices of transport, leisure activities, and restaurants and hotels. Governor of the Bank of England Mark Carney will have to write a letter to Philip Hammond, Chancellor of the Exchequer, explaining how the bank intends to bring inflation back to its 2% target. Current policy dictates that the governor write a letter to the chancellor if inflation is above 3% or below 1%. The last time this occurred was in December 2016, after inflation fell to 0.9% (October data). Even though the bank hiked administered interest rates in November, it decided to hold off at the December meeting. Still, the bank did state that higher rates would be needed over the next few years, in order to return inflation to its target.

Longer View

Following several years of a general expansion in the price-earnings ratio of equities, we believe returns from this asset class will moderate somewhat and become more closely tied to the rate of growth in company earnings. With equity market volatility increasing to at least the normal range, it’s important to keep in mind that equities are best suited for long-term investing, and that the allocation in your portfolio should reflect your investment horizon and risk tolerance. Fixed-income investments, while generally providing limited income in today’s low interest rate world, are an effective diversifier in a portfolio. When there is extreme pessimism in the equity market, fixed-income tends to outperform. There is no one asset class that looks better than others, in our view, as their current valuations accurately reflect their potential and risk. Talk to your professional advisor to ensure your portfolio is optimized and continues to meet your needs.

Courtesy of CI Funds

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