In this episode, we dive deep into the pressing issue of inflation in Canada and its far-reaching impact on the economy. Join us as we analyze the latest inflation report, discuss the three main drivers behind rising inflation, and explore the implications of higher interest rates.

Join the conversation as we unpack the intricacies of Canada’s economic landscape and its uncertain path forward amidst rising inflation and interest rate pressures. Don’t miss this insightful discussion on the challenges facing the Bank of Canada and what it means for Canadians in these turbulent times.

Hey, welcome back. I wanted to start today with a quote from Howard Marks. So Howard Marks, a prolific investor, has so many great quotes. If you want to spend an hour on the Internet looking through his quotes, go for it. You won’t waste it. This one in particular I was looking for because it always rings true in times like this when we see, you know. A really bad inflation number come out and everyone’s wondering what the next step for the Bank of Canada is.

And there’s so much fear in the market. It’s important to remember that this pendulum of psychology in investing is always swinging back and forth between greed and fear, between risk tolerance and risk aversion.

We’re seeing that now more than ever. So keep that in mind as we go through. We’ve got some slides that we’re going to show you today. So of top of mind right now for everybody, including the federal government, the Bank of Canada, most certainly, and every economist at every major bank is the inflation report that we just got out yesterday from Statistics Canada. It is very important to look at the three main drivers of this inflation report. Number one, gasoline prices.

This is of no secret to anyone who’s been watching our podcasts Gas prices and the price of oil increasing over the last couple of months is having a dramatic impact on inflation. There is nothing that the central banks can do about it. Maybe there’s something that the United States can do about it in terms of its foreign policy strategy as it deals with Saudi Arabia and the OPEC nations. But right now there is a economic war going on. And in order to exert control over their policies, the Saudi Arabia and OPEC nations are forcibly increasing the price of a barrel of oil that is trickling down the pump, and it is affecting our inflation numbers.

The next thing is that higher interest rates, which we’re using to combat inflation, are driving inflation because they’re increasing mortgage rates and shelter costs. I mean, you cannot open a newspaper or I guess a newspaper website without seeing how Canadians are feeling. The pressure of increased rentals increase cost of mortgages at renewal. That’s a really big thing right now. You know, people are renewing mortgages. You still have to renew a mortgage.

One and a half million people every single year are going to have to renew their mortgages, and they’re going to renew them from 2% to 6%. And that is driving inflation because the cost to hold on to someone’s house, the cost to rent a house is increasing and those increased rates are impacting the inflation numbers.

Finally, we’ve got food prices, right? Food prices are not abating. They continue to increase year over year. We saw another 6.9% year over year increase in food prices. So these three line items on the inflation report are all not as affected. We can’t target this. So what happened after the inflation report came out? Bond yields spikes; all of them spike. The two year rate is almost 5%. The five year rate is well over 4% now, close to 4.2%. And the ten year yield is almost at 4%. You’re seeing a real narrowing out of that inverted yield curve on the tail end of it.

The difference between the five-year period and the ten year is getting tighter, and that’s indicating that these higher interest rates are looking to be here for longer. We’re going to show you a slide towards the end that does show how quickly these yields will move and how they will be impacted by the Bank of Canada fighting an inflation with higher interest rates.

And that does move quickly right now. There is no doubt that this has created a ton of uncertainty for the market. The inflation numbers lead everyone to believe that the Bank of Canada is going to increase interest rates, that they don’t have a choice, but they do have a choice.

And we are seeing a lot of what the Bank of Canada is looking for coming into the economy right now. That is the pain and the uncertainty that everyone is feeling.

Unfortunately, that’s what they need to see in order for inflation to be brought in line. So we know that the Bank of Canada wants to see 2% inflation. We know that the Federal Reserve wants to see 2% inflation and we also hear the old saying don’t fight the Fed all the time. The problem is that pain is showing itself in average Canadian borrowers. Right.

Four out of ten mortgage lenders are borrowing to cover daily expenses, and that is up by almost 50%. These stats are troubling, right? Two thirds of mortgage holders are having a hard time meeting their financial commitments. Scary, right? Canada itself now has the worst debt ratio of any G7 country. We’re seeing a lot of sensitivity to interest rates as it was anticipated.

It’s important to know why inflation is so scary for central banks, governments, and policymakers. A bad recession will change the government, right? You’ll go from a liberal government to a conservative government. If there’s a really bad recession,.

People aren’t going to revolt in someone they perceive to be responsible for a bad economy. But massive inflation is very scary that will remove all governance, as it has in the past. Right? Like that’s we’re talking societal breakdown. People cannot afford anything. They cannot afford food and shelter at all because of massive inflation. So that’s why it’s so scary.

That’s why it’s being targeted the way it’s being targeted and the recession that may come about or has come about because of that targeting is a sacrifice as far as policymakers and the Bank of Canada is concerned. Let’s look at what’s happened so far. Right. We’re sitting at 7.2% prime rate right now. Are we even considering increasing interest rates another 25 basis points? A lot of the work that they’ve done still hasn’t been felt in the market. Look at what’s going on. Right.

Consumer spending in Canada has tanked. 11% of households only plan on making any type of large purchase in the next quarter. And I expect that number is going to come down more. Canada itself, as far as Canadians were last, as far as any intention to spend with relationship to any other country, any other country with a developed economy and 24% of Canadians are planning to apply for additional credit or refinance in the next 12 months.

So one in four people can’t meet their obligations and needs more money in a time when asset prices are dropping and debt servicing costs continue to increase. That’s what the Bank of Canada wants to see. That is one reason why it’s unlikely we’ll see another 25 basis points. Consumer confidence is paired with consumer spending. Obviously, consumer confidence is at its lowest point since the start of the pandemic, and that is at the end of August.

I expect that our September readings will be even lower than that. It’s the fact that this fear of inflation and further rate hikes, it’s just putting everyone on the sidelines. Nobody wants to spend whatever savings they have in a market like this because they will likely need it to service their debt. The Bank of Canada continued to reference unemployment. Have a look at the employment numbers. Right now, the employment numbers still appear to be healthy. The problem is, is that we have so many part time workers who don’t want to be part time workers. 20% of the part time workers in Canada do not want to be part time workers.

They’re looking for full time work and that’s not available because the labor market is softening within the labor force. People that have multiple jobs are looking for more jobs and are taking on these jobs out of necessity because they’re not getting enough income out of their employment to cover their debts, to cover their living expenses.

Finally, if you’re looking at the unemployment rate, people who were unemployed in July and June are remaining unemployed. Over half of the people that were actively looking for work. That’s what unemployed means. We’re still unemployed a month later. So they’re not finding the jobs that they’re looking for within the market because the labor market softening, which is what the Bank of Canada wants to see.

This is an important slide. It speaks to how quickly things can move. If you remember, in February and March, we had a pause in interest rates. The Federal Reserve had a pause, the Bank of Canada had a pause and we saw yields tank. The thing is, is those yields tanked as a result of a banking crisis that happened in the United States, not necessarily as a result of the pause that occurred within the bank, Canada, and the Federal Reserve.

Similarly, Ali, right now there is no breaking of anything in the financial system. So we’re seeing bond yields continue to ratchet up in the face of what these inflation numbers are showing. But any type of uncertainty in the financial markets, any future bad news will cause those bond yields to come back down again.

We’re just right now at a point where those inflation numbers are driving those bond yields because everyone is so fearful that what we’re seeing in the inflation numbers is going to drive up interest rates on the central bank level. So what are the banks telling us? The CEOs of the major banks are telling us that we probably are in store for another nine months of this.

Yesterday’s inflation reading sucks. It is fortunately driven by a few line items within the inflation report. The rest of the data that’s coming out of the Canadian economy is all positive towards what the Bank of Canada is trying to accomplish. Rest assured, the guys that are running the big banks in Canada have great visibility on what’s happening in the economy and what looks to be happening in the future.

It is kind of widely accepted right now that the middle of 2024 is when we will start seeing interest rates be biased towards coming down. Hiking the interest rate right now is not going to affect oil prices and gas prices at the pump and hiking the interest rate right now will increase the inflationary pressure within mortgage and shelter costs and it certainly won’t do anything to impact grocery costs.

The remaining underlying inflation numbers are all coming from items that are outside of the control of the central bank. The only thing the central bank can do right now is continue to exert this downward pressure on the economy as a whole. But I don’t think the economy needs any more downward pressure. We’ve already seen the things that the Bank of Canada wants to accomplish. Consumer spending is down. Consumer confidence sucks. The housing market is frozen. The labor market is softening. These are the things that the Bank of Canada wanted to see.

Unfortunately, at the start of this tightening process. Whatever the reason, Canadians, the G7 countries in general citizens had a lot of saving, a lot of money was printed. People had money in their bank accounts. So even in the face of increasing interest rates, they continue to spend and they continue to be confident. Now, those savings rates have dwindled and the impact of those interest rates is really being borne out on the economy.

In my opinion, based on what I’m seeing from these numbers, the economies of the G7 nations can’t really handle much more, and that is coming to light in these numbers. So where does that leave us? We’ve got these macro issues that aren’t going away. Canada needs homes. Right now, home sales are falling. New developments have frozen.

So we’re not going to see any of the new housing come online that we’re looking for. It’s very difficult to motivate developers and builders of rental units or condos or houses to start building in the face of higher interest rates and the prospect of no demand for purchasing. At the same time, we still have mortgages, right? People still have mortgages, and every single year mortgages need to renew. There are one and a half, almost one and a half million mortgages renewing every single year in Canada.