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As the summer months bring temperatures soaring, one thing that’s been moving in the opposite direction has been inflation. After massive government spending to fight COVID all around the world spiked inflation to double digits, central banks have been desperately spiking interest rates to bring inflation back down.
The theory was that by increasing the cost of money, the amount of spending in the economy would go down, resulting in less demand and therefore lower prices. In practice, this meant repeatedly taking a baseball bat to anyone holding a variable (or in Canada’s case, even fixed-rate) mortgage, spiking their monthly payments and sucking their budgets dry. Interest rate increases hurt people with debt, while inflation hurts everyone, so sacrificing indebted homeowners who signed up for massive mortgages to save everyone else seemed to be the mantra of 2023.
Well, it looks like it worked.
Canada’s inflation rate dropping to 2.8 per cent in June is a “milestone moment” that Canadians should find some relief in, according to Deputy Prime Minister and Finance Minister Chrystia Freeland.
Down from 3.4 per cent in May, the annual inflation rate has not been within the Bank of Canada’s target range of between one and three per cent since March 2021.
Canada’s finance minister calls inflation rate dropping within target range a ‘milestone moment’, CTVNews
Wowza. Inflation with a 2-handle? That’s something I didn’t think we’d see for a while, let alone so soon in 2023. We’ve all endured a lot of negative surprises over the past 3 years, so it feels rather nice to have a positive surprise for once.
Inflation in the G7
How does Canada’s inflation rate compare to the US, and other countries in the G7? Well, according to a tool published by the Financial Times, here is a country-by-country breakdown of the annualized inflation levels as of June 2023.
| Country | Inflation % (annualized) |
| Canada | 2.8% |
| USA | 3% |
| Japan | 3.2% |
| France | 4.5% |
| Italy | 6.4% |
| Germany | 6.4% |
| UK | 7.9% |
Canada’s inflation number is, for now at least, the lowest in the G7!
Before we go on, can we take a moment to recognize how incredibly unusual it is for Canada to be #1 at something? We can’t claim to be the biggest, or the richest, or the strongest militarily. In the Olympics, when we’re in the top 10 in terms of medal count, our media will crow “Hey, that’s pretty darned good!” Generally, we don’t expect to be the best at anything, we’re just happy if the US, the EU, or China looks over, pats us on the head and goes “Well, you sure tried your best there, sport!” So the fact that we’ve somehow managed to bring inflation down faster than any other country in the G7 is pretty impressive.
That being said, the US and Japan is not far behind. They’re so close, in fact, that I fully expect that in a month or two one of them will take the top spot. But until then, IN YOUR FACES, BITCHES! At least temporarily, anyway. Canadians take our fleeting moments of glory when we can get them.
France, Italy, and Germany, though, have a bit more work to do, with their inflation rates still hovering at 4-7% level. They’re making good progress, as their inflation numbers were all in the double digits in 2022, but they still have a bit of a ways to go.
However, I would not want to be in the UK right now. They’re sitting in dead last, having started raising interest rates way later and slower than everyone else. They also have to deal with the added hit of Brexit, since as it turns out taking control of your borders actually means that you can’t get goods, services, or workers into your country cheaply anymore. Their inflation will likely remain sticky for quite some time, since I really don’t think the EU is in any mood to let them back into the club anytime soon.
But no need to shed any tears for the UK. They had plenty of opportunities to undo the Brexit vote, yet they voted for it in multiple elections despite knowing the consequences, so let them reap what they sowed.
Everyone else, on the other hand, can pat themselves on the back for the progress they’ve made so far.
What Happens Next With Interest Rates
Any prediction on the future of interest rates is always, at best, an educated guess since none of us can read the minds of central bankers, but my educated guess is that Canada is likely done with interest rate hikes.
Interest rate changes take 6-12 months to fully work their way through the economy, so even if the Bank of Canada keeps its rate steady, inflation will still probably fall a bit more before it stabilizes. Where that stable level ends up is anybody’s guess, and it’s entirely possible that a rate cut could materialize if the Bank sees inflation drop too far, but that likely won’t happen until 2024 at the earliest.
The US Federal Reserve is widely expected to hike its benchmark rate one more time on July 26, and barring any unexpected world event hitting them (please no, I can’t take anymore excitement), it will probably stop there as well. The EU has some more room to go, so don’t expect the ECB to take its foot off the gas anytime soon.
And the UK is screwed, but once again, they did it to themselves, so whatever.
Effect on Investments Choices
With the current interest rate hiking cycle apparently coming to an end, how does this affect the investments we hold in our portfolio? Great question, imaginary straw man I just made up!
As an index investor, our overall portfolio allocation is based on our fundamental risk tolerance rather than anything we read about in the news, and because our ability to withstand volatility remains quite high, our allocation will remain at 75% equity/25% fixed income.
The equity indexes we invest in will also remain unchanged, evenly split between the TSX (Canada), the S&P 500 (USA), and the MSCI EAFE Index (Europe/Australia/Far East). The economic recovery may continue to be uneven around the globe, but I don’t see a strong enough reason to bias towards or away from any particular country, so we will remain globally diversified in our current configuration.
Our fixed income portion, on the other hand, may change. Right now, our 25% fixed income allocation, which is usually invested in an aggregate bond index, is currently invested in preferred shares (Ticker: ZPR). Preferred shares are a floating rate instrument which pay higher yields when interest rates rise, which is why we’re currently enjoying a dividend of about 6% from this asset class. Bonds, on the other hand, are currently paying about 3.5%. So we’re getting a nice boost in our portfolio yield by holding these.
However, now that Canada is shifting away from a rising interest rate environment into a neutral, or even slightly negative interest rate outlook, the time may be coming soon to move back into a plain vanilla bond index. I’m not in any rush, though, since I want to see a sustained period of no changes from both the Bank of Canada and the Federal Reserve before I’m fully convinced that interest rate hikes are over. Plus, the longer I wait, the longer I get to keep collecting that sweet sweet 6% dividend!
Conclusion
So there we have it. Inflation in Canada has officially hit our 1%-3% target, with the US and Japan due to hit theirs a little while later. Personally, I’m super stoked that something seems to be going according to plan, because for a while I wasn’t convinced that anyone knew how to solve this stubbornly high inflation we’ve been seeing since 2022.
The future remains uncertain, as always. Economists still widely predict a recession, though who knows when/if that will happen. There’s still a vicious war in Ukraine going on, and a US election coming down the pipe next year that promises to be even more chaotic than the last one (if that’s even possible). But rather than worry about all the stuff that could go wrong, I choose to focus on the one thing that appears to be going right, which is inflation finally going back to normal.
What do you think? Do you think we’ve finally beaten inflation, or is this yet another fake-out? Let’s hear it in the comments below!
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Another great write-up. Love the Canada stories.
zpr- preferred shares are a wealth killer. never understood people chasing its yield .
agree, with a high MER of 0.5, ZPR doesn’t yield 6% at all.
Savings accounts and CDs are giving out 5% to 6% interest — and the principal is guaranteed! No fees either.
No capital growth either.
No capital collapse either!
( How far has ZPR fallen over the last year, last 5 years? )
Did you see my other comment below? I’m up more than 10% for 2023. In a well diversified portfolio, some things go up and some things go down. That’s life. No one can predict the future. On the other hand, I’m doing fantastic financially. As a couple, we are north of $2.4 million just in marketable securities.
Your savings accounts or CDs would never have gotten us to where we’re at. Taking calculated risks is a part of life.
Agreed !!!
Because I need the yield more than capital growth. I’m not using preferred shares in place of equity, I’m using it in place of bond indexes that are (for some reason) still paying 3.5% yield despite a BoC rate of 5%.
My question is how accurate is the inflation calculation? Actual inflation on mandatory expenses like food, gas, housing is much much higher than the official inflation number. I think they are scared to report the real inflation as it would send the country into a panic. I’d guess real inflation is like 15%.
Yup…
I find it very hard to believe much of what’s this government is reporting.
Go tell people in the street price only rose 2.8% since last year. Everyone knows that’s not the case.
I’d like to see how this 2.8% mindset is really calculated and what’s included in this
It’s based on the Consumer Price Index, which is an indexed basket of goods and services. Personal inflation will depend on your personal consumption which varies widely. For example, if a mortgage is a major part of your monthly expenses, then you’ll probably see a much higher personal inflation than someone who rents.
I know it’s based on the cpi and personal habits play a role. But the cost of mandatory items like food gas housing affects everyone. And there’s no way those itmes have only risen 2.8% or whatever. That’s out by likely an order of magnitude.
I think this is another fake-out. The inflation rate will probably bottom out during 2023 before going back up in 2024.
Lots of the lower value in the current inflation rate is due to temporary effects, for example oil and used cars being lower than 2022 because of the Russia/Ukraine war and supply chain distruptions in 2022. Now, those issues are resolved (lower inflation) but we see more and more persistent inflation (increasing wages, rents, financing costs).
Inflation does not move in a strait line. It move more like waves. We got the first wave in 2022. Now we are in a trough in 2023. I expect we will get another inflation wave in 2024.
If you look at the price of oil, for example, it was $105/bbl in June 2022 and got down to $70/bbl in June 2023, for a -33% YoY decrease. Today, it’s already up to $79/bbl, for a 13% increase, which will impact future inflation rates (between July 2023 to June 2024).
Another example, India just banned rice export last week. This is also very typical in inflationary environment. Not only will it increase the price of rice everywhere else in the world, but it will also decrease the price of rice in India, which will discourage farmers to produce more rice. If this policy is maintained long term, this will push prices higher and higher, because lower production means higher prices.
Since oil and rice are amongst the most basic products for everyone everywhere in the world, we can fairly expect that it will increase prices of many other products or services that we buy …
One last comment regarding your post : “The theory was that by increasing the cost of money, the amount of spending in the economy would go down, resulting in less demand and therefore lower prices.”
This theory is not really correct. It only looks at one side of the coin, the borrowers, while completely ignoring the effect on the other side, ie. the impact on savers.
Since it is true that an increase in the cost of borrowing may lower the spending of borrowers, it is also equally true that increasing revenues for savers due to higher interest rates may increase their spending in the economy, as for every amount of dollars borrowed there is an equal amount of dollars lent to those borrowers by savers.
For example, in my particular situation, I have borrowed at 1.84% on my mortgage until 2026. The proceed is invested in short term treasury bills now yielding 5%. So, in my situation, the higher the Bank of Canada increase interest rates, the more money I have available for spending. So, this would be inflationary. I just hope there is not too much people doing the same thing as I am doing, otherwise, my gain will be offset by inflation … :-/ LOL
If I exclude those transactions (ie. my T-bills essentially offseting my mortgage), the rest of my portfolio is 100% invested in equities.
My expectation for interest rates (just for fun) :
– Short term interest rates should eventually go down in 2024 to around 4%.
– Long term interest rates should move higher, from 3.5% to around 5%.
I still think interest rates on long term bonds are too low. There could be more losses for bondholders if interest rates move higher too quickly.
However, short term rates are very expensive for governments. So I expect they will lower the rate as soon as they have a chance to do so.
This would also allow us to return to a more “normal” interest yield curve.
Anyway, those are just my predictions. I guess we will see in the future what happen in reality !
That’s a really interesting take, because I also think long term rates are waaaay too low. It’s got to correct to a normal yield curve at some point, and I think it will be very painful when it happens.
Ben Miller, CEO of Fundrise just did a podcast “The Case for a Recession”, https://open.spotify.com/show/1srZfhGJwCMRQILijMT8BE.
He couldn’t reconcile what he was seeing “on the street” while making transactions (credit is drying up) with what he is seeing in the stock market so he did some research on every recession in recent history. He found that recessions start around 18 months after interest rates start to come down – so he would predict a recession for us around mid 2024.
Your thoughts?
I know you guys are anti real estate but I wonder what you think of Fundrise?
This make sense. Governments lower interest rates when the economy is weakening in order to stimulate the economy. If they wait for too long, then the economy weakens too much and we fall into a recession.
I’ve been expecting an inflationary recession since 2021 and it didn’t happened yet. Maybe we are due for one in 2024.
What will be interesting is if we have an official recession and that the inflation rate goes higher at the same time … In this situation, governments would be really screwed !
Either they stimulate the economy to try to get the economy out of a recession but they increase inflation by doing so. Or they increase interest rates even higher to combat inflation but the economy falls into an even deeper recession …
Again, we shall see … (interesting time to be alive)
Interest rates come down after a recession, not before.
And I looked into Fundrise. It’s not insured by FDIC or SIPC, so if they go belly up all your money’s gone. Would not touch.
Is BLPEF the US equivalent for ZPR? Also – ZPR seems to have high expense ratios and management fees. I thought we were supposed to avoid those. ?
I think PFF is the US equivalent. They’re actually paying 6.75% right now, so that’s pretty sweet.
And yes preferred shares do have higher fees, but I will tolerate higher fees for Yield Shield assets if I it allows me to maintain a dividend that I can live off of. Plus, at some point I will get out of this asset and return back to a plain vanilla bond index, but only when the price is right!
The ZAG bond index ETF is down about 20% from its peak right now. Isn’t now a good time to buy?
Preferreds are down like %7 over the past 6 months. How is this your fixed income solution? Lol
Correct, they’re trading at a significant discount right now. Which is why I picked up more in June during a rebalance.
ZPR has a total return of -0.11% since inception in 2012, yet suffered 30-40% drawdowns during the COVID crash and 2022 bear market, so it can’t even serve as a good diversifier to stocks. It’s a similar situation with CPD. I would stay far away from preferred ETFs. Total risk/return is the only thing that matters to building your wealth, not distributions!
Yeah, but as a floating rate instrument, this is an asset that should outperform when interest rates rise. Other commentors have noted that they haven’t performed as they should so far this year, but I think they’re trading at a discount. We’ll see who’s right in the end…
We’re doing the same as you with 80% stocks but have 20% money markets as the fixed income part of portfolio. Can’t beat the 5% guaranteed return without loss of capital!
Regarding the EU. EU is a basket case of high inflation and recession. I wouldn’t be so fast to single out the UK. Near majorities of EU citizens in Poland, Hungary, Denmark, Austria, Netherlands, Spain, France, Germany, Slovakia, Czech are turning to parties that demand power be removed from EU bureaucrats in Brussels and returned to nation states. The EU is run by the same corrupt condescending bribe-taking Authoritarians as the International Olympic Committee and FIFA.
Could you imagine if political stability of Europe, such as it’s defence against Russia ,was left to the EU instead of NATO and the US? The EU would still be in committee with a timid and befuddled response to the Ukraine crisis over a year ago.
Thankfully Europe has NATO, UK and the US to give it political stability and doesn’t have to depend on the dithering EU
Oh, I agree that all is not perfect in the EU. It’s just the UK is just doing so much worse, and I find that hilarious.
“The EU is run by the same corrupt condescending bribe-taking Authoritarians…” The EU is run by the nations that are in the EU. These nations have the power to shape the EU.
The suggestion that the EU is some kind of overlord type, self-serving, corrupt institution is incorrect. It’s not! The people of the UK have found out the hard way, believing the many lies of those pushing for the fantasy of a better world outside the EU club. It’s costing them dearly for little to no tangible gain whatsoever.
Hey, someone out there compose a 1980s-style pop tune titled “Inflation Nation!”
Dan V
Nantou (at the moment), Taiwan–1.8%
You’re looking at headline inflation. The Bank of Canada focuses on core inflation which is currently just below 4%. Your thesis on where inflation is at in Canada is therefore flawed.
https://www.bnnbloomberg.ca/inflation-has-fallen-but-the-bank-of-canada-hasn-t-backed-off-rate-hikes-here-s-why-1.1949753
As for your portfolio, not bad. Looks like you’re sitting around 9.90% ytd. I’m at 10.16%. Life is tough. 😂
Very nicely done. What’s your allocation, if you don’t mind me asking?
Just a reminder that the Brexit referendum in the UK was only won by a 52% majority. Nearly half of the UK voters and some countries voted to remain eg. Scotland. And now these people and countries are sadly dealing with the consequences of something they wholly do not support.
Yeah, my good friends Alan & Katie Donegan both voted Remain while their entire families voted Leave and are now dealing with the consequences. I’m sure those family gatherings are awkward AF.
On the numbers: 17.4 million people voted to take away the freedom of movement, excellent trade and job/retirement opportunities from 67 million people, including themselves, their children, and their grandchildren. Mostly based on the outright lies they were told. It’s such a shame that so many people couldn’t see what they had, until it had gone. It’s utterly terrifying that so many people are that easily duped!
“ Interest rate increases hurt people with debt, while inflation hurts everyone”
Inflation and debt is good for those with fixed rate loans. Their effective repayments are reduced.
True, though here in Canada even our fixed rate loans reset ever 5 years, so nobody gets to have truly fixed rate mortgages up here.
Long term investors do not mind short term inflation.
Their portfolio needs these short term inflation for long term growth.
Non-investors (blue or white labor) hate inflation. They bear the burden of inflation, without any benefits of long term investment growth.
Move away from consumption and move toward investment people!
lol Canada is part of the G7? Who wouldn’t bet…so insignificant worldwide