Whether it’s North America or other continents, raising interest rates is the weapon of central banks to combat inflation. The recent 75-basis-point increase by the U.S. Federal Reserve was its biggest hike since 1994. It had to implement a supersized hike because the U.S. annual consumer inflation (8.6%) in May 2022 was the highest level in more than 40 years.
In Canada, inflation (6.7% in April) is also rampant in that a 0.75% hike on July 13, 2022, is almost set in stone. BMO Economics and RBC Economics predicts that the inflation reading in May 2022 to be higher at 7.4%. Don Drummond, an economist and fellow with Queen’s University, said the Feds must raise their policy rate above 3%.
Deputy Prime Minister and Finance Minister Chrystia Freeland confirmed that the forecast for the global economy has significant uncertainty amid high inflation, the Ukraine war, and supply chain kinks. However, she believes that Canada’s economy is well suited compared to some if its G7 allies to weather the storm. The country’s agricultural output and low unemployment rate are the strengths.
Impact on the stock market
The impact of rising interest rates on the stock market is immediate. There’s no delayed reaction whatsoever because the fear of lower corporate earnings or profits can send share prices tumbling. It happened last week when the TSX had its worst week in more than two years.
Brenda O’Connor-Juanas, a senior vice-president with investment banking firm UBS, said, “The market is digesting what 75 points means and asking, can the Fed continue this aggressive cycle without triggering a recession?” She added, “We have an overheated economy and there’s only one way to cool it off, and it’s going to be painful.”
Notably, Bloomberg data showed that the value of announced IPOs from Canadian companies plunged 79% from a year ago to about $1.37 billion this year through May 2022. Sante Corona, head of equity capital markets at TD Securities, said, “It is shocking how quickly equity issuance can decline.”
Look for stability
No one knows how fast the aggressive rate-hike campaigns of central banks, including the Bank of Canada, will put an end to inflation worries. Investors must manage their expectations on earnings and look for stability. Canada’s banking sector is a bedrock of stability, and the big banks have endured economic downturns and financial crises.
Toronto-Dominion Bank (TSX:TD)(NYSE:TD) stands out for its resilience during the 2008 financial crisis. In 2020, Canada’s second-largest bank wasn’t spared from the pandemic-induced market selloff. The share price sunk to as low as $47.12 on March 12, 2020, when the TSX suffered a 12% drop in one day.
As of this writing, the big bank stock trades at $87.33 per share (-8.32% year to date) and pays a 4.12% dividend. The $160.84 bank didn’t join its industry peers in raising dividends after the earnings releases for Q2 fiscal 2022. Investors shouldn’t mind the decision, because TD is preparing to take over First Horizon Corp. in the U.S. by Q1 fiscal 2023. It will become the sixth-largest bank in America.
Stay invested
The smart approach to mitigate market risks in today’s environment is to stay invested in companies that can pay stable dividends.
