Further tightening, depleted savings could undo resilient economy

Despite concerns of an economic downturn, the North American economy has displayed an impressive level of resilience, especially in the face of rising interest rates.

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“The economy, and particularly the North American economy, has been much more resilient than consensus,” said Luc de la Durantaye, chief investment officer at CIBC Asset Management.

This resilience is even more noteworthy considering the rate at which interest rates have been rising.

One key element behind the economic resilience, de la Durantaye said, is excess savings accumulated by consumers during the pandemic.

Government support and reduced spending during the crisis led to historically elevated savings, which has been supporting consumption. However, de la Durantaye said excess savings are nearing depletion, raising the possibility of a slowdown in consumption in the coming months.

“In the second half of the year, we could see something that is a bit different or see a bit more weakness from consumption,” he said.

Another factor contributing to the economy’s resilience has been commercial bank lending rates. Initially, de la Durantaye said these rates did not mirror the rise in market interest rates, providing a cushioning effect for the economy.

However, lending rates are catching up with market rates, diminishing this protective impact.

De la Durantaye also highlighted quantitative tightening as a more technical issue, particularly in the U.S.

The tightening process was disrupted by the events surrounding the U.S. debt ceiling, resulting in interest rates remaining lower than expected. However, he said rates have started to rise again since avoiding the fiscal cliff in early June.

“Those are the elements that have helped the U.S. economy [. . .] hold up better than most people expected,” he said.

Looking ahead, de la Durantaye predicts growth to decelerate in the second half of the year due to the second wave of central bank tightening. Multiple central banks, including the Bank of Canada and the Federal Reserve, have signalled their intent to raise rates, with the Bank of Canada hiking its key interest rate to 5% last week.

Balancing the need to achieve inflation targets while avoiding an excessive economic slowdown amid high levels of debt in developed economies will be a challenging task for central banks, de la Durantaye said.

Based on his analysis, de la Durantaye advises maintaining a low-duration bond portfolio, which enables investors to benefit from rising interest rates. “Don’t forget, you’re getting paid much better today than you were a year or two ago,” he said.

In real terms, current returns are better than a year or two ago due to declining inflation.

On the equity side, de la Durantaye recommends adopting a defensive posture and considering sectors that provide stability and reliable dividends.

“You want to be exposed to some of the defensive sectors that provide good dividends that are going to get you that cash flow again,” he said.

De la Durantaye also addresses the theme of artificial intelligence (AI), acknowledging its long-term potential. “It looks to be an important revolution to be invested in,” he said.

However, he said investors should be cautious in expecting immediate boosts from AI investments, given the uncertainties surrounding the economy and central bank actions. Instead, he said investors should exercise patience and seek opportunities in the AI theme over the next six to 12 months, aligning with the trajectory of central bank tightening.

“Being patient, I think, is going to be rewarded,” he said.

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