Recession Risk: When the Central Bank Stops Being Boring

May 26, 2023

The Bank of Canada’s monetary policy should be boring. Like a hockey or soccer referee, people shouldn’t notice it. If they do, it usually means a contentious decision has been made. Interest-rate policy and inflation figures shouldn’t be the main topic of discussion around an average family dinner table.

In essence, this is the thinking behind the central bank’s inflation-targeting approach. You will have heard Governor Tiff Macklem (and numerous commentators) talk about 2% as if it’s some magical number. In the Bank of Canada’s eyes, it kind of is as it set the target itself. Just like a steady referee, the idea is that at 2%, inflation goes unnoticed: it’s enough for economic growth but low enough not to cause havoc with your energy or grocery bills. The trouble is, to stretch the metaphor to breaking point, the hockey referee has been the main story for over a year.

After the COVID lockdowns, inflation soared because of a rare cocktail1 of central banks flooding the economy with liquidity to prevent a 2008-style crash; supply and demand mismatches; and soaring energy costs, in part because of trade sanctions on Russia after its invasion of Ukraine.

Inflation in Canada started climbing in early 20212, peaking at 8.1% in June 2022. The Bank of Canada, which had previously said it would keep interest rates “lower for longer” was forced into an about-turn. Starting March 2022, it raised its benchmark rate eight consecutive times, taking it from 0.25% to 4.5%. A year on from kick-starting this cycle, it has now paused to let these increases fully work through the economy. Helped by the easing of supply chain issues, inflation has subsided to 4.3% but remains above the 2% target.

Are we heading into a recession?

What does all this mean for the economy and for your investment portfolio? Are we set for more market volatility? Despite the central bank’s efforts, the economy remains strong in places, particular the labour market and real estate, despite the latter cooling slightly. Are rate increases simply taking time to have an impact or is something else going on? Will another hike be needed?

Confused? Fear not, you are far from alone. Like bringing a plane into land, the big question is whether the Bank of Canada’s bid to get inflation under control will result in a soft or hard landing. Macklem & Co. obviously want the first option and will probably take a shallow recession that slows the economy enough to get inflation back to around 2% without causing too much damage. The issue for investors is that there is little consensus about what happens next. According to the World Economic Forum, 45% of chief economists think a global recession is likely this year, only for another 45% to disagree. The Conference Board of Canada put their recession risk tracker at 95% but quickly cover themselves by adding this doesn’t mean it will happen.

This is a highly unusual time in history and typical economic gauges are not reliable. Let’s be honest, very few economists have lived through a global pandemic, a huge military conflict and decades-high inflation.

Adding to the confusion are the markets, which are predicting rate cuts as early as late 2023, believing central banks will need to stimulate growth sooner rather than later. But both Macklem and his U.S. counterpart Jay Powell have clearly prioritized getting inflation under control. The investment adage goes “don’t fight the Fed” but markets, if they haven’t yet thrown a punch, are certainly calling them out.

All this combined suggests more volatility while we work through a messy end to this economic cycle.

Investment strategy

In times of uncertainty, basic investment fundamentals are vital so, firstly, don’t try to time the market. Remember, no one knows exactly what is going to happen and when. Historically, this is an easy argument. Since 1930, if an investor missed the S&P 500′s 10 best days each decade, the total return would stand at 28% but if they stayed invested, the return would have been 17,715%3. Ride it out. Secondly, arm your portfolio accordingly with the best form of defence – diversification. Think not just in terms of asset classes but spread your money across industries, geographies and different-sized companies.


Fixed income has certainly been given a shot in the arm by the rate increases – some are even calling it a ‘generational opportunity’. If you believe inflation will remain sticky and central banks will wait to cut rates, the front end of the yield curve looks attractive, offering 4% to 5%. Given the early signals of pausing, or even easing, the hike cycle, some measured duration risk may also be appropriate. A barbell approach, where the investor buys only short-term or long-term bonds, is worth considering. If the markets are wrong, you’re still protected.


If rates linger higher, there will likely be a shift from macro to micro, where investing is more about the quality of individual companies than the decisions of central bankers. As has been shown by the collapse of some US regional banks and the mass layoffs in the tech sector, some firms have dealt with the new economic environment better than others. Typical areas that thrive during recessions are utilities (hydro and water), consumer staples (everyone has to eat), infrastructure (have you seen downtown Toronto?), and healthcare (people still get sick). As mentioned, the economy remains relatively strong and there’s an argument to be overweight equities, especially if you drop the growth/tech focus of recent years.


The debates over the 60-40 portfolio model rage on and this traditional approach model looks more attractive now that bonds are offering more than just scraps. Another view, if you haven’t already, is to consider a 50-30-20 model, which gives you 20% exposure to alternative investments like gold, private equity, private debt, and long-short strategies. There are factors to consider, like illiquidity and time horizon, but certain areas offer attractive returns and, crucially, diversification from stocks and bonds, which dropped in lockstep during the pandemic crash.

At this fork in the economic road, it’s easy to panic but professional advice can help you navigate the issues discussed while ensuring you stay focused on your long-term financial goals. What works for one investor may be a disaster for another – everybody’s life is different. At a time when every expert seems to put forward a different forecast, put your faith in your financial advisor to show you the way.




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