Why recent market volatility is unlikely to affect interest rate cuts in Canada and the US: an analysis

August 20, 2024 TruthUSA

When the markets took a plunge on Aug. 5, it was partly attributed to the Bank of Japan’s recent decision to raise its key interest rate to 0.25 percent after ending eight years of negative interest rates earlier this year.

As the markets recovered in the next several days, so did Japan’s Nikkei, following reassurances from the deputy governor of the Bank of Japan Shinichi Uchida that a further hike at this time is unlikely. In making this declaration, Uchida cited the market volatility as the reason.

“As we are seeing sharp volatility in domestic and overseas financial markets, it’s necessary to maintain current levels of monetary easing for the time being,” said Shinichi Uchida on Aug. 7.

But the situation is different with central banks in countries like the United States and Canada, analysts say.

“The Bank of Canada will adjust interest rates depending on inflation,” said Philip Cross, a fellow at the Macdonald-Laurier Institute and a former chief economic analyst at Statistics Canada.

“They have an inflation mandate. They don’t have a stock market mandate.”

Ian Lee, an associate professor at Carleton University’s Sprott School of Business, said officials are more likely to examine metrics such as productivity, inflation, growth rates, and unemployment when deciding whether to modify interest rates, as opposed to examining the movement of the stock market.

Even if decision-makers pay attention to stocks, he added, they are unlikely to look at “day-to-day fluctuations.”

“If you’re going to look at the stock market at all, look at the yearly plus or minus of a particular company. So did share value go up over the whole year or not?” Lee said. “But don’t use day-to-day gyrations, because it’s just too volatile and too erratic, and it’s not useful for interpretation.”

Market Fluctuations

Stock markets across the world plummeted on Monday, Aug. 5, following a U.S. Department of Labour jobs report released the previous Friday that showed job growth coming in “below expectations,” with just 114,000 jobs added in July.

The Dow Jones Industrial Average fell by 2.7 percent as soon as markets opened at 9:30 a.m., while the S&P 500 dropped by 4.1 percent and Japan’s Nikkei 225 index fell by around 12 percent.

However, by Aug. 9, the Dow Jones was just 0.6 percent below its previous position, and the S&P 500 had virtually recovered from the drop, down by less than 0.1 percent for the week. Japan’s Nikkei 225 also recovered much of its losses by the end of the week.

“The market went down very dramatically for 24 to 48 hours, then it came back up,” Lee said. “Markets are very powerful, but because they undershoot and overshoot, we should not be using short-term gyrations in the capital markets as compelling indicators of where the economy is going.”

Bank of Japan

The Bank of Japan’s role in contributing to the Aug. 5 stock market plunge goes back to 2016, when it lowered its key interest rate below zero to try to stimulate the country’s economy. It wasn’t until March 19 this year that it raised the rate from -0.1 percent to a range of zero percent to 0.1 percent, a move that impacted traders who had been borrowing the Japanese yen at low rates. Then on July 31, the Japanese central bank raised the rate to 0.25 percent.

Cross said the Bank of Japan behaves somewhat differently from other central banks and is more likely to change monetary policy based on the stock market’s performance.

“Quantitative easing in North America meant central banks bought bonds and mortgage rates to bring down long-term rates. In Japan, they didn’t just buy bonds, they bought stocks,” Cross said.

“They just have a whole different way of operating their financial markets, completely different from ours.”

US Likely to Cut Rates

Despite the Bank of Canada making two interest rate cuts in 2024, the U.S. Federal Reserve has not followed the same path. At its latest announcement, on July 31, the U.S. central bank said it would maintain a target range of 5.25 percent to 5.5 percent due to the “uncertain” economic outlook.

Lee said economic growth has been “fundamentally stronger” in the United States compared to Canada over the last three years, which is why the Bank of Canada decided to cut interest rates.

“But I do believe the Fed is going to reduce rates this fall, and not just in September. They may reduce them again in November or December,” he said.

Stephen Williamson, an economics professor at Western University and a former Bank of Canada fellow, said inflation numbers in the United States look “pretty good” at 2.9 percent year over year in July, and he is not sure why policymakers at the Federal Reserve are not proceeding with rate cuts.

He would be “very surprised” if the Federal Reserve doesn’t decide to cut interest rates at its next meeting in September, Williamson said.

Livio Di Matteo, an economics professor at Lakehead University, also believes the Americans will cut interest rates in 2024, which will help determine the direction of the stock market.

“Given that recession concerns in the U.S. are moderating in the wake of relatively good job numbers and cooling inflation, the odds of a U.S. rate cut in September are growing, which should buttress markets in the short term,” he said.

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