The “art” of forecasting

Economic data

The summer months are usually characterized by a little bit of a slower pace when vacations and warmer weather take center stage. However, this summer will prove to be different, as headline risk and market events swing volatility from one week to the next. The two dominant events this week were the Bank of Canada’s (BoC) interest rate decision, and the US consumer price index (CPI) figures for the month of June. First, the BoC chose to once again raise interest rates by 0.25%, bringing the overnight rate to 5.00%, a level not seen in almost 20 years! ?

With this week’s bank meeting, we also got another look at a new monetary policy report (MPR), which once again saw revisions to the bank’s expectations for inflation and growth. The forecast for GDP growth was moved higher for 2023 to 1.8% (up from 1.4%), while inflation is expected to settle at 3.7% in 2023 (up from 3.5%). More importantly on the inflation front, the Bank did not see inflation getting back to target until mid-2025. The statement from the meeting reflected a more hawkish tone, but at the press conference Governor Macklem sounded more balanced and dovish. Ultimately, the Bank tried to convey a message that it’ll be data dependent going into the next meeting in September. During the press conference, the Governor faced tough questions regarding the “conditional pause” decision made earlier this year, which he admitted came down to the Bank’s ability to forecast near term variables and their impact on the economy.?

Forecasting in general has proven to be problematic post-pandemic and in the current cycle, and end of cycle predictions likely will prove to be no different. The BoC is struggling to incorporate in its forecasts the record amount of immigration Canada is currently experiencing, coupled with the impact current interest rate levels are having on households. The one thing we can most likely forecast is that current forecasts will need to be revised. Over the long term, these elevated interest rates will significantly impact the Canadian economy. The only forecast that matters will be how long that road is to our ultimate regrettable destination.?

South of the border we got CPI numbers for June, which were constructive with the headline number falling to 3% year over year, representing the lowest level since the spring of 2021. Outside of the headline number, the details always proved positive with the core monthly figure coming in at 0.158% (4.8% year over year) and the Fed’s “super-core” measure moving to 4.01% year over year from 4.62%; another lowest reading since the end of 2021. Although inflation measures beat on the downside, the benefit from base effects have now been exhausted after this reading, and it is expected the headline number will trend higher over the remaining summer months. But, if we continue to see monthly figures posting inside of 0.25%, we will be on a trajectory to reach the Fed’s 2% CPI target range. June producer price index (PPI) data also showed easing cost pressures with headline and core moving to 0.1% and below expectations. All three measure of PPI (headline, core, and core-core) slowed from the previous month and the headline print was the lowest since the summer of 2020. Overall, PPI data continues to point to easing consumer price pressures. ?

Bond market reaction

Rates on the week had a strong rally, with 10-year government of Canada yields moving lower by almost 20?basis points (bps), while 10-year US Treasuries outperformed on the week by moving lower by almost 30 bps. The move lower in yields was accompanied by a bull steepening in the interest rate curve (meaning shorter dated bond yields fell more than longer dated bond yields), with the Canada 5-30 year yield curve increasing by over 15 bps as the market downplayed the notion of “higher for longer”, causing shorter dated bonds to outperform. Markets are fully priced in for one more hike by the Fed, while there is a less than 50% chance that the BoC will make one more hike before the year is over.?

Stock market reaction

It was another strong rally for equites this week, with both the TSX and S&P?500 gaining between 2 and 3%. That brings the year-to-date return for the TSX to 7% and a spectacularly strong 18% for the S&P?500. We won’t even mention the 36% gain for the Nasdaq as to not upset the bears sitting on the sidelines in anticipation of the always imminent recession. Much of the strength this week can be attributed to the tamer inflation data in the US, with markets brushing off the rate hike in Canada and the anticipated hike next week by the Fed, and instead focusing on the fact that rate hikes are approaching the final innings of this tightening cycle. It was a very busy week in corporate news, with TransAlta announcing the rollup of their renewables subsidiary, Laurentian Bank unofficially placing themselves on the sales block, Intact Financial disclosing heightened catastrophe losses, and Aritzia providing another quarter of disappointing forward guidance. Next week kicks off earnings season in the US, followed a week later by Canada, where we will be watching for indicators of a slowing consumer, although we certainly did not see early signs of that in Amazon’s Prime Day figures this week.?

What to watch next week

Next week in the US we get retail sales for the month of June, while in Canada we’ll get a look at retail sales for the month of May. More importantly, we’ll get Canadian CPI for the month of June with the market looking for a similar constructive move like the one experienced this week in the US.

Authors: Adam Ditkofsky, Pablo Martinez, Sandor Polgar, Steven Lampert, Craig Jerusalim and Rahul Bhambhani

Adam Ditkofsky is Senior Portfolio Manager, Global Fixed Income; Pablo Martinez is Portfolio Manager, Global Fixed Income; Sandor Polgar, Portfolio Manager, Global Fixed Income; Steven Lampert is Senior Research Analyst, Investment Research; Craig Jerusalim is Executive Director and Portfolio Manager, Equities; and Rahul Bhambhani is Portfolio Manager, Global Equities.

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