The lagging impact of interest rate hikes on the economy

Nader Hamid, Portfolio Manager with TWM Group at iA Private Wealth presents our video. You can also see this video in French presented by Maxime Lagacé-Carter by clicking here
Despite all the talk of a possible recession and one of the fastest interest rate hike campaigns in history, the economy seems to be humming along. Why are we seeing this disconnect?

As with past recessions, the answer may be in the lag, or the length of time it takes for the economy to feel the impact of the rate increases.

Historically, it takes between 18 to 24 months after the last interest rate increase for the full impact to be felt across the economy. So even though employment strength and general spending may lull us into believing we have avoided the worst of the economic drawdown, it’s just too early to tell. The table in our video clearly shows how things have unfolded in previous cycles.

The first impact is generally seen in Consumer Credit. This will show up in higher credit card balances, car loan rates, and other short-term financing.

Housing typically isn’t affected at first, and prices start softening only after 6 to 12 months. We’ve already seen a slight decrease in housing prices, and we’re nowhere near the level of intense bidding wars we witnessed last year.

However, we still don’t know when the Bank of Canada will stop interest rate hikes, so house prices may still have some way to go before stabilizing. Especially considering the many fixed-term mortgages at low rates which are yet to come due. In Canada, an opposite force may complicate this downside pattern: our strong immigration incentives and our housing shortage.

Commercial Loans and Business Investing are normally next to feel the impacts. As consumers spend less because of higher credit rates, businesses respond by borrowing less and investing less in their future growth.

When business activity starts to slow down, excess capacity and inventories start to build, and then we see Inflation turning over.

Unemployment is normally the last one to turn. Businesses which are affected by lower sales try to protect their profit margins, normally leading to layoffs.

That’s why employment is a lagging indicator and should not be used as a sign of future economic health.

The Key Takeaway?

The most recent interest rate increase by the Bank of Canada was on the 7th of June, and we are still unsure if it will be the last one. But assuming it is the last one, the lagging effects of these hikes on the economy are unfortunately likely to continue and reach their peak into 2025.

We have adjusted our portfolios to be more defensive over the next 12-18 months. These environments always create opportunities in several asset classes and have always been beneficial for patient investors.

On behalf of the TWM Group, thank you for watching, and see you next time.

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