How to Get Ahead of Expected Rate Cuts

The last push is always the hardest—and while interest rate hikes have ceased, central banks now appear hesitant to begin cutting as inflation proves stubborn. Still, the general consensus is that the Bank of Canada (BoC) and the U.S. Federal Reserve (Fed) are nearing a tipping point. Talks have turned to timing, with expectations for rate cuts to come around the middle of the year, followed by greater volatility. In this uncertain environment, here are the themes to keep an eye on and potential opportunities to get ahead of rate cuts.

Canada: Will the BoC have the luxury of staying higher for longer?

Since as far back as 2016, Canadian household debt as a proportion of disposable income has exceeded 180%.¹ That means, for every dollar of household disposable income, Canadians owe around $1.80. This is a well-known problem, which makes Canada more sensitive to interest rate hikes than the U.S., where they have a lower leverage ratio. In our view, the household leverage problem’s impact on growth and the destruction of demand in the Canadian economy is a potential reason for the BoC to ease rates.

At the time of writing, we see expectations of between three and four rate cuts being priced into the market for 2024. However, this is down significantly from six cuts priced into the market in January. The pendulum appears to have swung from optimism to more realistic expectations. If the BoC holds rates higher for longer, we could see the short end of the curve continue to provide some protection for investors, outperforming longer-duration exposure in the near term. While we still believe that duration will be a key driver of returns this year, a slower cutting cycle by the BoC would likely lead to some near-term outperformance of shorter-term bonds as rate expectations reset.

Overnight Rate

United States: Cuts may be coming, but when?

The Fed and the BoC are likely at an end to intense monetary policy-tightening campaigns. Still, there is a danger in doing the opposite, of moving too soon and reigniting inflation. In a 60 Minutes interview, Fed Chair Jerome Powell said a March cut was unlikely. The U.S. has seen core inflation slow but remain elevated. Therefore, the Fed will need to see evidence that demand is cooling. The signs, however, say otherwise. The gross domestic product (GDP) and employment numbers grew unexpectedly from October through December 2023 in a surprising display of economic resilience.

The central theme in the market is uncertainty itself. Fortunately, many investors have the privilege of waiting patiently on the sidelines, looking for an opportunity or a signal. When you can earn 5% to park cash, it can pay to wait. There continues to be value in the short end, with protection from some of the uncertainty in markets right now. That said, in the longer term—over the course of 2024—we believe longer duration will outperform as rate cuts come to fruition. For this, timing will be everything. Right now, the 10- and 30-year yields remain relatively tight. While we’ve seen some widening, we believe they still have room to go up. Before acting, we’d like to see longer-term yields jump 25 to 50 basis points or the labour market to suddenly show signs of strain.

For investors looking to get in without having to worry about timing the market perfectly, the BMO Aggregate Bond ETF Fund, with a 0.09% MER, offers a one-ticket solution. The Fund invests in all domestic investment grade bonds with full-term exposure. So, you get the protection of the short end and exposure to long duration, which can help you take advantage of cuts if they come.

Global: Tides are turning in Europe.

After a challenging year, the European economy essentially stagnated, which is much better than what was originally feared—an outright recession. We believe the worst is behind for Europe, as the energy crisis that began 18 months ago is stabilizing, and we are starting to see modest improvement. While not booming, it is not a bad backdrop for investors; however, Europe remains in a tough spot. Competition is heating up in the electric vehicle race as China attempts to dominate the field, ultimately hurting the core of industrial production for the European economy.

Strategies to manage fixed income uncertainty

To navigate these volatile markets, investors must equip themselves with effective tools to manage uncertainty. The BMO Ultra Short-Term Bond ETF Fund is positioned to maximize yield–and can be more advantageous than midterm (3-5 year) guaranteed investment certificates (GIC) and high interest savings account (HISA) rates²–but gives investors the flexibility to remain nimble in the market. While sitting on the short end of the curve, investors might consider adding duration exposure using the BMO Aggregate Bond ETF Fund or BMO Corporate Bond ETF Fund. As we said earlier, we think duration is going to be a winning trade for the remainder of 2024. At any rate, if we get a “soft landing” or “no landing” scenario, the corporate bond exposure should perform well in the environment ahead.

Please contact your BMO Global Asset Management wholesaler for any additional support and guidance.

¹(2023, December 13). Household sector credit market summary table, seasonally adjusted estimates. Statistics Canada.

²Based on the best 5-year GIC (4.75%) and HISA (4.00%) rates available on NerdWallet, a comparison site, as of February 27, 2024.