The U.S. could send interest rates soaring in the fight against inflation.
Interest rates seem to be the “never-ending story” these days, but there are so many twists and turns to it. Sometimes we tend to navel-gaze as Canadians because we have some resilience in our systems, but we’re a small, open economy in a great big global world, and the recession clouds outside our borders are growing week by week, and often day by day.
China is probably already in a recession, and Europe is likely heading into one this winter, with its war-related energy crisis on top of high interest rates. The third big global block is the U.S., and in recent weeks we heard that its central bank plans to take its interest rates higher than anyone anticipated. Right now, it’s 3.25% and everyone thought it may go to 3.50% or even 3.75%, but the overnight rate is now expected to go to a staggering 5.0% by early next year.
“Softer” Canadian dollar
If the U.S. raises its rates this aggressively, what does it mean for Canada? Currencies around the world—including here at home—are already soft against the safe-haven flight to the U.S. greenback. Higher U.S. rates, along with louder recessionary fears, will reinforce this trend, putting more upside pressure on interest rates in Canada while importing more inflationary pressures from the higher U.S. dollar.
That means higher financing rates for vehicles, and it will shave off some of that consumption appetite that we appreciated a couple of months ago. Inventory is still a challenge with the supply chains still recovering, and dealers can sell whatever they can put on their lots, but we see more headwinds coming up that will, in turn, see the average Canadian facing a multitude of challenges to their “purchasing psyche.”
Passing “peak” wealth
So-called “peak wealth” has passed and Canadians are now feeling it. The wealth effect—meaning what Canadians see in their financial situations and their homes, hinges on the state of the economy. Investments are falling and house prices have dropped from their peak last February, so consumers are feeling poorer than they did at the beginning of the year even if they are still in good financial stead. That’s affecting their appetite to spend, even before they realize how expensive it’s going to be to purchase large goods.
As always, there are plus-and-minus aspects to this. We’re not done with the interest rate hikes, but inflation should start to tick down. We saw the month-over-month numbers pivot in August with some inflation cooling in Canada. You can’t depend on one month, but we did see a decline and it’s a green shoot of optimism.
Wages will go up, inflation should come down
Wages are picking up, with hourly wages in August increasing month-over-month by about 10% on an annualized basis, which is well above where inflation is going. Wages still aren’t compensating for inflation, but they tend to go up with a lag effect, as people renegotiate their salaries or find better-paying jobs. Even if interest rates and the cost of financing go up over the next year and a half, we should simultaneously see wages increasing and inflation coming down. Overall affordability should see some signs of improvement, even with the unemployment that we expect will increase slightly with the broader slowdown in the economy.
Dealers are going to have to look at individual buyers and their income vulnerability as we head into this next phase of the economy. The story continues, and we have to expect some twists to the plot.