We all watch with interest as the American Politicians fuss and fight over the extension of the U.S. debt ceiling. Investors have lots of questions with no real answers. When will quantitative easing actually cease? Why does the U.S. Fed change its mind and where of course, where do we go from here?
Ben Bernanke‚Äôs perfect script is a ‚Äúbeautiful deleveraging‚ÄĚ which assumes minimal defaults and an eventual return of investors willingness to take risk again. To meet the U.S. Fed‚Äôs objective to grow normally again, there is likely no more better deleveraging solution than one accomplished via low interest rates for a long, long time. Big brother‚Äôs actions always dramatically affect our Canadian financial scene.
The last time the U.S. economy was this highly levered was in the early 1940s and it took over 25 years of low interest rates to accomplish deleveraging.
The reality is that they can‚Äôt keep adding one trillion dollars to their balance sheet every year without a negative result. Basic economics would say the U.S. may eventually have accelerating inflation, decreasing dollar and poor investment in the economy if they continue down this path of uncontrolled debt increases.
It is generally understood that quantitative easing and injecting investment into the economy was necessary for rather uncertain and illiquid times. Many feel it is time to restore a more set policy and gradual increase to normal rates. The U.S. decision makers are faced with the question of how high can one raise rates in a levered economy. The slight increases in the U.S. over the past few months have seemed to stop new housing starts and importantly mortgage refinancing. Housing in both the U.S. and Canada are extremely sensitive to interest rates.
The perfect plan is for the U.S. economy to grow at real growth rates of two to three per cent. Like anything man made the perfect script will be hard to follow. The market‚Äôs recent adjustment in recognizing higher interest rates ahead may be overdone. Predictions that the U.S. fed funds to be one per cent higher by late 2015 and one per cent higher in 2016 may be difficult to meet.
Look for low interest rates in Canada and a weaker Canadian dollar. A weak Canadian dollar will help kick start the Ontario manufacturing sector. Ontario like Germany and Japan needs a weak currency to bolster exports and make for increased profitability and investment in the manufacturing sector.
History and experiences of the past would argue that the U.S. may be forced to keep interest rates lower for a longer time then the politicians‚Äô hope. Even with quantitative easing gone a highly levered U.S. and global economy cannot deleverage without abnormally low interest rates. The effect on Canada is always there, not only on interest rates and our economy, but more importantly the value of currencies, which may be the real story to watch as we move forward.
And through all this noise what does one do. Be content to buy higher quality securities of good Canadian and U.S. companies with attractive yields and growth potential. Winners normally continue to win, luck normally occurs occasionally at the horse track.
Stephen Maltby is an Investment Advisor and Chartered Accountant with CIBC Wood Gundy .He has been in the financial services industry for more then 30 years and has held various accounting, investment and management positions with several accounting and investment firms over the years.He is in addition to his Advisor role a First Vice-President and Executive Director Atlantic Canada,Cibc Wood Gundy.