67. 4.5% Interest Rates, Grocery Prices and Tech Layoffs
4.5% Interest Rates, Grocery Prices and Tech Layoffs
A quick look at a few news items that caught my attention recently about the latest Bank of Canada rate increase, grocery price increases coming and layoffs in the tech industry.
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Transcript:
Hello and welcome back to the Canadian Money Roadmap Podcast. I'm your host, Evan Neufeld.
Today we're taking a bit of a break from our series on building your investment approach, and we're just going to do a bit of a roundup about the news, some things about interest rates, a little bit about inflation, and what's going on with layoffs in the tech industry. Before we get started here, I wanted to give a quick shout out to a listener on Apple Podcasts. This is from MCK Keener 44. Keener left a great review of the podcast. I wanted to give a quick shout out to them. They said “I love that it's Canadian. It's clear, concise, and delivered well, I've thoroughly enjoyed listening. Thank you so much for your podcast.” Well, thank you so much for listening. If you're new to the podcast here, that's hopefully what you can expect from the podcast. I try to be clear and concise and not give too much banter that waste your time and just give you the information you need to make better decisions with your money.
So as I said in the intro, this is going to be a bit of a news episode where we're going to talk about what's going on in the world a little bit. I'd like to do this a bit more. If you haven't noticed, I've adjusted my upload schedule. I'm trying to do this weekly now from I was doing every other week for a while, and I thought, let's give weekly a try. If we're going to be recording that often, I thought I could spend some time taking a look at some current events and talking about how those might affect you as the listener.
So the first item I want to talk about here is that Canadian interest rates have increased again, and this is the eighth time it has happened. I believe since March of last year is when they first started and so this has been a pretty aggressive interest rate hiking cycle, but the Bank of Canada's kind of signaled here that they anticipate pausing rate hikes from here on out. They always leave the door open for future hikes if inflation seems to creep back in or continue on an upward trajectory. But inflation seems to be well on its way down from, it’s all time peaks and given where inflation was last year, we kind of have a higher baseline effect looking at inflation for this year. So it might start looking like inflation is really coming down quite aggressively. But that's just one thing to be aware of, that we just have a comparison point that's much higher than we would've the year before. So it might look artificially lower than you'd expect. But paying those prices that you were used to probably isn't going to happen anytime soon because that is closer to deflation than low amounts of inflation.
But anyways, this news item is about the bank raising interest rates again. So now the policy rate is 4.5%, and that doesn't really mean anything to you because that's more of a behind the scenes rate that banks use. But the thing that will affect you as the listener and the borrower is the prime rate. And the prime rate is the rate that banks will charge consumers for lending products and prime is just kind of like a baseline. So usually say a line of credit will be prime plus one, prime plus three, whatever, but it is just the baseline that they use to figure out how much to charge on interest for loans. So when the prime rate goes up, the debt that you have on a variable product, so like home equity, lines of credit, variable rate mortgages, those are the big ones. Your borrowing cost just went up again. But if you're on a fixed rate mortgage, if you have a car loan, in most cases your rate won't change in this case until you have to renew it. If you have to renew your loan, it's going to be renewed at a higher rate than, than where you got it at.
So the big thing with rising interest rates here and the prime rate of 6.7%, it doesn't sound like a crazy amount of interest to some people maybe, and maybe it isn't, but the last time the prime rate was this high was in the first half of 2001. So we haven't seen interest rates this high in 22 years. I think I'm doing the math right there, 22 years since we've seen interest rates this high. So what happens when interest rates go up? Well, the cost of borrowing goes up. For us as Canadians, we've got the most expensive housing market on the planet relative to incomes, and so that means for most of us that are borrowing money, the cost of buying a home just went up again pretty significantly.
So let's just think about economics here. What happens when the cost of borrowing goes up? Well, the price of those things should come down. And so if we look at housing in Canada here, the Benchmark Canada home price drops 17% as a result here from its peak in February of last year. So it really depends on your real estate. Every city is going to have a bit of a different market, but on average, housing prices are coming down, which in some cases is a good thing. But when housing prices go down and borrowing rates go up, oftentimes the mortgage payment doesn't end up being much different at all. So the cost that ends up just going to the bank as opposed to going into the value of your home is gone up. So even though prices are coming down, it's coming down along with an added expense in terms of more interest. So not necessarily great for borrowers and people looking to buy a house.
The interesting thing with mortgage rates, however, is that fixed rates and variable rates are structured differently and their baselines are calculated differently. So with a variable rate, it's usually tied to the prime rate, which again I mentioned is 6.7. And for most variable mortgages, it'll be prime minus a certain factor. Some of the numbers that I've seen before put a five-year variable rate now at about 5.8%, so that's like prime minus 0.9. However, five-year fixed mortgages are usually tied to bond yields. I'm not going to get into that too much, but essentially the bond market will move kind of in anticipation of rate changes. And so the Bank of Canada raising interest rates here was a surprise to no one. And so the bond market had kind of adjusted prices accordingly already because people buy and sell bonds based on what they think is going to happen in the future. And so when there's a consensus assumption that rates were going to go up again, the bond market had already accounted for that. And so even though interest rates went up again, five year fixed or all the other different terms, but fixed rate mortgages actually declined in some cases. because the bond market, which is kind of like the stock market, they react to expectations and whether things were better or worse than expected. Not necessarily if things were good or bad. I would say rising interest rates are just generally bad. It just makes things more expensive. But when the market understands, It's probably going to happen when reality comes in and it's either better or worse than that, that's when the market will move. So because this rate increase was largely anticipated, it hasn't really affected Fixed term mortgage rates, and in some cases they've actually declined, even though interest rates have gone up.
So let's move on to another story here. This was an article from The Financial Post and the headline here says “Food price hikes coming in February as cost blackout ends. Metro CEO says”, so Metro is a grocery chain based out of Quebec. If you're not in Quebec, you probably haven't heard of them, but they are a massive player in grocery and pharmacy out there. So this isn't some fly-by-night guy making a claim, but he was talking how the grocery industry works, and he said, I'm going to just read from part of the article here. His name is Eric La Flèche, and he said that his chain Metro, like most of its rivals, run an annual blackout on all cost increases from mid-November until February. As a way of making things as simple as possible during the all-important holiday rush. That meant that food suppliers, so those that are selling to the grocery store, couldn't ask groceries for more money, even though inflation tore through the supply chain, making fuel and freighted packaging more expensive. So the requests piled up. So my understanding here, he's saying that Metro and other grocery stores will simply not pay more for their product, even though the suppliers are charging a higher price, meaning us as the consumer had been paying an artificially low price based on what that product had cost initially.
So what's going to happen now is that Metro, and he claims that other grocers are going to be doing the same thing, is that now that this blackout period, whatever they're calling it is over, they're going to start raising prices again based on what their suppliers are charging. Back in October, Loblaws had a big marketing campaign talking about freezing prices on its in-store brand no name.
I think it was just on the No name products. And they had a big ad campaign about it, you know, seeing their store as a kind of an inflation buster, whatever. But Mr. La Flèche from Metro argues that was just a long-time agreement industry-wide. He said, that's a long-time practice at our company and as far as we know at most retailers, but again, we don't speak for others. He was pretty careful here. He wasn't calling anybody out, but he said we had a blackout period and we didn't accept cost increase. Loblaws was arguing that what they did was unlike anything done before in the industry so this is interesting here. So the unique thing with the inflation story and the CPI or the consumer price index is that it factors many, many, many different products that some people may or may not use. So things like cars or air travel, or hotels, or even things like meat. You might be a vegetarian, who cares about the price of steak.
And so if you're looking at the CPI number and it ends up being, let's call it 6%. That doesn't mean that every single thing you buy costs 6% more. That means that on average, the basket of goods that's used to calculate the consumer price index on average is up 6%. Your personal inflation rate might be significantly higher or lower than that based on the things that you actually buy in your day-to-day life. However, most of us need food to survive, and so buying groceries is a big part of that. So most of us have felt the inflation of groceries pretty significantly, and that's where a lot of the CPI increases had come from. But it's a little discouraging to see this article because metro is arguing that those prices were actually still lower than what you should expect going forward. So maybe this is just a little public service announcement to put away a little bit more cash next month and going forward for groceries that may get more espensive.
The last news item that I'm going to discuss here on this episode relates to tech industry layoffs. And for those that have been predicting a recession for a short period of time or a long period of time, they're pointing towards these layoffs in the industry as a predictor of the “coming recession”. I'm using air quotes here, you can't see them. Now, I'm not saying that a recession might not come, but I'm going to try to give a bit of a different explanation as to what's going on here in the tech industry. Tech is just kind of a catchall term it seems for companies that exist digitally, but you could probably argue that is Amazon a tech company? It's like, well, no, they're online retail store essentially, but they get categorized as a tech company. But looking at companies like Facebook, Google, Amazon, Salesforce, Microsoft, booking.com, Cisco, IBM, Uber, Twitter, SAP, Groupon, Peloton, Carvana. A lot of these tech companies, most of those you probably would've heard of have started laying people off. And so far since the start of 2022 website that tracks this for the industry says that there's been over 225,000 tech layoffs since the beginning of last year. That's pretty significant. That's a ton, especially for folks that are earning good money. Those are typically high earning jobs, software developers and things like that. And so I definitely want to start off by addressing the human element here and try not to minimize the fact that these are real people, like 225,000. That's pretty much the size of Regina. Everybody laid off in one industry, largely in the US, but those people now, have to live off their savings, apply for other jobs. Lots of these companies won't be doing much hiring, and so staying in a similar industry might actually be quite challenging. Who knows? But these are real people that are now living off their emergency funds. Most companies offer pretty good severance packages and take care of them decently well that way, but it doesn't mean that it's easy for these people to just pack up and leave. So some people are trying to see this as a predictor of pain to come in the economy, you know, as someone say a leading indicator of the economy. I would argue that it is probably the opposite. It's probably a lagging indicator due to the changes in interest rates.
So when interest rates are low, that means borrowing costs are low, and so you can afford to raise money. There's a huge risk appetite because you have to take big swings to make money as an investor, and so a lot of that money gets funneled over to riskier and riskier places. Companies will do the same thing, so if Google has an idea, Google's parent company is called Alphabet. If Alphabet has some wild and crazy ideas for the last 10 years or so, they could afford to do that because even if they didn't have the cash on hand, which they do, it didn't even matter. Because they could borrow money for virtually nothing and they would just keep hiring, keep hiring, keep trying and seeing what sticks.
You could kind of run a spaghetti at the wall type of business because the cost of trying was really low. But the cost of trying things means that you need a lot of people and a lot of these tech companies were hiring like mad just since COVID 19. Again in the case of Meta Facebook, I read somewhere that in the last couple of years they had essentially doubled their headcount, which is crazy. That's a ton of people and a ton of hiring. Facebook is no longer known as Facebook. I guess it's, it's Meta because they're throwing money and people at this concept of the metaverse and they're trying stuff and that made sense because interest rates were zero. It really isn't that crazy of an explanation in my mind. Let's look at Google again for a second or alphabet. They have a whole department dedicated to moonshots this, this department's called X and If you find their website, they call themselves the Moonshot factory, and you read through some of the stuff that they're going through there and it's like, oh my goodness, that's pretty cool. The homepage has like those robots going through farmer's fields and all sorts of crazy things with robotics and self-driving cars and providing affordable internet, all these different things. So they founded this department in 2010. Any idea what the effective federal funds rate in the US was in 2010? In January 2010, the effective rate was 0.1. Today, as I'm looking at it at the end of January here, 4.1. Okay, so as a percentage increase, I'm not going to do the math there, but it's huge, absolutely massive, right?
So when Google's moonshot division started, you could borrow money for nothing, and that stayed the same until about 2016. Crept up again until about 2.4% right before Covid hit, and then drop like a stone again afterwards, back down to zero. And here we are again at four. So since companies like Alphabet have been experimenting with these moonshots, they could hire, they could grow, they had different teams all over the place. Well now the story has changed, because now your stock price is getting cut due to interest rates going up and there're being alternative options. Part of the role of a CEO or these public companies, their job is to increase shareholder value. Their job, fortunately or unfortunately, depending on how you see it, is not to provide unlimited, high paying jobs to have a spaghetti at the wall operation. Their job is to make money. And the Moonshot division of Alphabet last quarter, any guesses? Maybe just in your own mind, take a guess and think how much revenue that division added for Google. Keep in mind, they own things like YouTube, Google Search is the big one. The last quarter alone that they reported, it's Q3 of 2022. They had 69 billion of revenue. However, the category that takes a look at their moonshots division. They just refer to it as other bets in their financial reporting, it accounted for 0.3% of their total revenue and that's not unusual. That's how it's always been. So for 13 years, dumping money and people into something that doesn't add to revenues, and that's just looking at revenues. I didn't look at the expenses, but I would say it would be a negative that's no longer doable in higher interest rate environment. And so unfortunately, people are the victims here. So the people that we're working on some of these projects, they get looked at first as places to cut expenses.
Google has all sorts of stuff. They're looking at things in healthcare and self-driving cars and all this kind of stuff. And guess what happened late last year? Chat GPT showed up and really gave Google a scare, and so they've diverted a number of their staff and efforts over to artificial intelligence, which they already spend a ton of time, money, and effort on. But now when interest rates are no longer zero, it's not best story wins, it's not best idea gets a billion dollars for nothing, it's like, no, we actually have to allocate our resources diligently. And this is exactly the same as it is for you and I. When the economy gets tough, when inflation is high, so the cost of everything is higher and the cost of borrowing is higher, we have to be better stewards with the stuff that we have.
Doing a renovation project might not be doable. Landscaping the yard might not be doable. Getting a new car might not be doable. So when you and I are tightening our belts a little bit, companies end up doing the same thing. On the surface, it seems kind of ridiculous. When a company's making 69 billion of revenue in a quarter and they fire a few thousand people, it's like drop in the bucket it seems like. However, it's unfortunately just a reflection of where the macro economy is and what the priorities of companies are going to be going forward as a result of what's happening. So I don't think it's necessarily a predictor of bad things to come. I think it's simply a reaction to the costs of, of doing business and the priorities needing to change for some of those companies. If you violently disagree with me, I'd love to hear from you. I'm not going to get into arguments with people or anything like that. Just curious to see what you think. If you like this kind of episode too, I'd love to hear from you. My contact info is always in the show notes. Thanks so much for joining me on this episode, and we'll be back with another episode in our series on building your investment approach next week.
Thanks for listening to this episode of the Canadian Money Roadmap Podcast. Any rates of return or investments discussed are historical or hypothetical, and are intended to be used for educational purposes only. You should always consult with your financial, legal, and tax advisors before making changes to your financial plan. Evan Neufeld is a Certified Financial Planner and registered investment fund advisor. Mutual funds and ETFs are provided by Sterling Mutuals Inc.