Three key factors affecting Canadians in 2024
“As the consumer goes, so go the markets.”
– Macan Nia, Co-Chief Investment Strategist, Manulife Investment Management
As we look ahead to 2024, three key factors are affecting the health of the consumer: the knock-on effect of higher interest rates, sticky inflation and the rising cost of living. This trifecta may be finally wearing down the consumer to the point that purse strings must be tightened and consumption on discretionary items and services could pull back as the focus falls on fixed costs, such as mortgage, vehicle payments and utilities. So where does that leave the health of the consumer and the economy today?
Peak interest rates
Interest rates affect everything, including mortgage and loan payments, and the price of gas and groceries. With the intention of slowing inflationary pressures, central banks around the world have been increasing interest rates at an unprecedented rate. But as we approach the winter of 2023, are they finally hitting an inflexion point?
“Our view is that the US Federal Reserve and Bank of Canada are likely to remain on pause with respect to their interest rates.” – Macan Nia
U.S. federal funds rate and Bank of Canada rate.
March 2022 to October 2023
While central banks enter the “wait and see” phase, the consumer is left with higher mortgage rates and higher interest rates on personal loans and lines of credit. This means that a larger portion of a person’s take home pay will need to go toward servicing debt as opposed to purchasing new products and services. The mortgage servicing issue is especially troubling in Canada, especially among Canadians who are saddled with a variable rate mortgage. Interest rates have increased to the point where these products are hitting a “trigger rate,” and the monthly payment no longer covers the interest portion of the loan. This may result in requests for balloon payments at the end of the term. On the fixed rate side of the mortgage spectrum, almost two-thirds of Canadians with a mortgage have not renewed it since interest rates began to increase. Over the next two years, more and more homeowners in Canada will be renewing at higher rates, further eroding consumer purchasing power. But it’s not just interest rates that affect the consumer – the inflation impact also plays an important role.
Slowing inflation remains persistent and sticky
If we’ve learned anything about the inflation story over the past 36 months, it’s that it is resilient. It started off as a transitory problem caused by COVID-19-related supply and demand price increases. As a massive government stimulus flowed into the system, many households experienced a build-up of savings. When lockdowns were lifted, many people deployed this excess wealth back into the system, creating even more demand, which prompted a hiring boom. The excess pressure on the labour market created wage inflation, which is not transitory.
So, for companies to keep up with the increasing wage demands, they’ve been forced to pass these costs on to the consumer – with the price of gas, food, services - even used cars - increasing considerably over the last 36 months.
Canada Inflation Rate
October 2021 to September 2023
Business access to cheap debt is also drying up, with the overnight rate set by the Bank of Canada now sitting at 5 per cent. This rate affects the cost of financing for corporations, all the way down to car loans and lines of credit, and businesses must adjust their prices accordingly. Unsurprisingly, those excess savings enjoyed by many consumers have now been eroded to all-time lows with credit card balances and personal lines of credit sitting at multi-year highs.
The cost of living
With the average cost of groceries rising 17.3 per cent  over the last two years, it’s easy to see why consumers face more and more pressure. When you add rising interest payments on mortgage rates, and more expensive car and personal loans, the cost of servicing debt is growing. Only one-third of Canadians have had to renew their mortgages at higher rates. The other two-thirds are coming due from now until around 2026, and monthly payments could jump significantly.
Three-year mortgage, five-year mortgage and prime rates in Canada
March 2022 - October 2023
“When so much of your family income is used to finance debt, sure, that’s going to have a significant impact,”
– David Frazer, Regional Vice President, Business Development, Manulife Bank.
Homeownership is highly regarded in Canada, and as such, is the very last place to expect to see delinquencies. But the added pressure is anticipated to cause a pullback in other spending. With these factors in mind, how might 2024 look in a typical portfolio?
The outlook for 2024
Within the context of a slowing global economy, heightened geopolitical risks, falling but sticky inflation, and central banks that are committed to higher-for-longer interest rates, a lack of severe market volatility may end up giving investors a false sense of security. In terms of valuation, on a trailing price/earnings ratio basis many global indices appear undervalued, relative to their individual longer-term history, but not materially so. Even though the S&P 500 appears fairly valued, much of that can be attributed to the recent rally of the top weights in the index.
“In economic environments such as these, it’s often best to look at individual security selection rather than specific geographies or sectors. Further, a well-diversified portfolio could help smooth out the ride should we experience choppy waters over the near term.” – Macan Nia. A full outlook from the CMS team is available here.
Coming into 2023, fixed income was expected to rebound from its poor showing in 2022, but persistent inflation and central banks’ raising of the overnight rate more times than expected has caused recent underperformance. Right now, “clipping the coupon” in fixed income seems to be the prudent thing to do. With the FED and the bank of Canada closely eyeing the data with regard to economic conditions the next move in overnight rates could be lower. This would bode well for fixed income in 2024. The CMS team has identified three key stages for fixed income. More information about each stage and what to watch out for in the fixed income market is available here.
 All data is from Statistics Canada's consumer price index tracker(opens in a new tab). Data updates once per month.