Markets may be pricing in ideal scenarios

The U.S. consumer will drive a resilient economy this year, while Canada is likely to struggle with weak growth and sticky wage inflation, said CIBC Asset Management’s Michael Sager.

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Strong household real income growth will continue to support consumer spending in the U.S., said Sager, managing director and head of multi-asset and currency management at CIBC Asset Management, in a late-January interview.

Conversely, Canada’s economic data is expected to remain weak, even though inflation has come down faster than anticipated, he said.

One key challenge facing the Bank of Canada is the stickiness of wage inflation, which is currently running above the target pace. According to Sager, the Bank of Canada must walk a “tightrope,” waiting for data to demonstrate weakening in wage inflation.

“Until that happens, there’s a tug of war between weaker consumer price inflation, weak economic activity, but still too-strong wage inflation,” he said. 

In contrast, Sager said the situation in the U.S. is more benign. 

The Federal Reserve’s core personal consumption expenditures (PCE) index returned to the target range in the second half of 2023, Sager said. The challenge now for the Fed is to adjust interest rates at a pace that doesn’t promote too much growth or leave the economy with excessively high real interest rates.

“At the moment it looks like a very benign outcome, a Goldilocks-type outcome, for the U.S.,” he said. 

That said, markets are pricing in ideal scenarios for both the Federal Reserve and the Bank of Canada in terms of interest rate policies in 2024, Sager said. He suggested that central banks will begin the easing cycle in 2024, but likely won’t cut rates as much as expected.

In this environment, Sager characterized his view for equities and bonds as cautiously optimistic.

In the U.S. market, high valuations and margins pose potential headwinds. Sager highlighted the importance of selective investing in countries and indexes with strong fundamentals and reasonable valuations.

The market’s expectation of rate cuts by central banks could potentially lead to bond yields rising more than anticipated, Sager said, which could, in turn, create potentially better entry points.

“We view bonds as a key part of many investors’ strategic portfolios, and certainly much more attractive than they’ve been for a while,” he said. 

In terms of the Canadian dollar’s outlook for 2024, Sager was less optimistic. 

Despite starting from an undervalued position, the Canadian dollar could become cheaper relative to the U.S. dollar due to the country’s economic challenges, he said, particularly in the consumer sector and the housing market. 

“The Bank of Canada is walking an economic and inflation tightrope that makes it difficult to be positive on the Canadian dollar,” he said.

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