As expected the Bank of Canada (BOC) issued their Monetary Policy Report (MPR) earlier in April and held interest rates at their current level of 1.25%. The BOC has taken a cautious tone on the back of a series of dovish signals. Canadian GDP unexpectedly fell in January on a month-over-month (MoM) basis, triggering concerns that first quarter GDP could be tracking well below the BoC’s forecast. Meanwhile, uncertainties around NAFTA remain a major source of risk as multiple rounds of negotiations have failed to yield any agreement so far, although recent developments look optimistic. Sensitivity of housing activity to interest rates also weighed on the central bank’s decisions. Despite a small pickup in MoM housing activity in March following two consecutive months of declining home sales (-13.8% in January and -6.5% in February), the Canadian housing market remains very sensitive to government policy changes, clouding the outlook for home prices. However, rising inflation in Canada paints a more hawkish picture, with Scotia Economics projecting 2.2% inflation this year and 2.3% in 2019, well above the BoC’s 2% target. In the meantime, communication from the BoC could trigger near-term market volatility, especially at the short end of the Canadian yield curve and in the Canadian dollar.
Global markets have struggled to make new gains since late February. In our view, this is partly due to concerns surrounding widening trade frictions between the U.S. and its major trading partners, heightening fears of a potential global trade war. Thus far, U.S. trade action has targeted certain products (i.e. steel and aluminum). However, recent talk of broader economic sanctions directed at China and aimed at reducing the U.S.’s trade deficit with the world’s second largest economy could increase risks of an escalation. As long as protectionist action remains modest in scale and focused on a few products, then risks of a global trade war should remain contained, in our view, helping to ease market anxiety. Near-term market focus should shift to monetary policy. The Fed’s rate hiking cycle remains on course with Jerome Powell earlier steering the U.S. Federal Open Market Committee to its first increase in the Fed target rate (25bp) to 1.75% since taking over as Chairman of the Fed early this year. Key for investors is the evolving trajectory for interest rates over the remainder of this year and 2019. The Fed has reconfirmed a gradual approach to its interest rate hiking plans (target 3%), leaving expectations for this year at three rate hikes (75bp) while bumping up its 2019 projection to a three rate hike (75bp) pace, reflecting its optimistic outlook for the economy. As a result, the environment for equity market volatility has changed noticeably in recent months.