Dis-inflation track

Canadian investors weren’t given much time to recover following a restful (and food full) Thanksgiving long weekend. That’s because Canadian Consumer Price Index (CPI) for September arrived on Tuesday, a particularly key data point ahead of the Bank of Canada’s (BoC) interest rate decision next week. It was a constructive print for the BoC, with the headline figure coming in below expectations at -0.4% Month-over-Month (M/M), bringing the annual rate to 1.6%—well below the 2% target for the first time since early 2021. As we’ve written before, that’s something to be celebrated considering the extraordinary bout of inflation experienced over the past two years.

The good news extended to the details of the report too. The mean of the BoC’s preferred inflation measures (core-median and core-trim CPI) averaged 2.35% for the month and 2.1% on a three-month trailing basis. The disinflationary progress appears quite broad-based. Only 30% of the inflation basket accelerating more than 3% per year offsetting notoriously sticky shelter inflation which is5.0% Year-over-Year (Y/Y).?

The read through to the bond market was meaningful, given futures are now nearly pricing in a 50 basis point (bps) jumbo cut from the BoC next week. The odds are also tilting towards a subsequent 50 bps rate cut in December.? The pricing for next week’s decision makes sense despite the fact that the BoC has already reduced its overnight rate three times this year. Considering inflation is now below the BoC’s official 2% target, Canadian gross domestic product (GDP) is trending weaker than the BoC’s most recent forecast. And, the US Federal Reserve (Fed) already primed the market with its own atypical 50 bps cut. However, pricing for a subsequent 50 bps move by the BoC in December is likely too dovish because it would risk further widen the policy rate difference between Canada and the US. That difference has grown recently as economic data south of the border (specifically job data) has been surprisingly strong. The reason this is important and is likely to draw the attention of the BoC is because of the potential inflationary impact from a further depreciation of the Canadian dollar. That’s why a regular 25 bps reduction in December is a more likely outcome for the BoC at this juncture.

Speaking of US data. Surprising to the upside, retail sales for September beat expectations at 0.4% M/M, up from 0.1% prior. The control group (which excludes more volatile retail categories) advanced even further by 0.7% M/M, well ahead of the 0.3% consensus estimate. Overall, it’s continued evidence of a more resilient US consumer benefiting from the stronger than expected job market. However, it ultimately further muddles the near-term rate path for the Fed.

Bond market reaction

US and Canadian bond yields moved in opposite directions this week, largely owing to the divergence in economic data discussed above. Front-end Government of Canada bonds rallied on the constructive CPI print causing the yield curve to steepen. Separately, as widely expected, the European Central Bank (ECB) opted to cut its key lending rate by 25 bps on Thursday. This is the third reduction of the year and is reflective of a weakening European economy. Risk assets generally remain well behaved as Q3 earnings season is off to a solid start. Canadian corporate credit spreads were mostly unchanged as primary supply expectations have underwhelmed. That’s a tailwind supporting strong demand for secondary corporate bonds.

Stock market reaction

The bull market in US equities has officially turned two, as measured by the last 20%+ drawdown. Canadian equities are demonstrating an equally impressive performance, achieving a staggering 119% total return since the Covid-19 lows without experiencing a similar drawdown. Earnings multiples rerated higher, more so in the US than in Canada, fueling the equity return surge and propelling the S&P500 and S&P/TSX to all-time record highs. However, valuation alone is not a reliable predictor of future drawdowns. A more accurate indicator is earnings growth, which continues to exceed expectations in early US Q3 reporting.

TSMC provided a bullish outlook, driven by the AI boom, offsetting some of the negative impact from ASML's guidance cut due to weakness in non-AI markets. The real champions this week were the banks. Strong earnings per share beats were delivered across the board. Credit losses came in lower than expected and banks posted exceptionally strong capital markets and investment banking results. Canadian banks also led the TSX this week, with CIBC hitting a fresh all-time high and surging 75% over the past 12 months. The only Canadian bank not joining the rally was TD, which remains under pressure following an unexpected asset cap in the US.

In other news, Alimentation Couche-Tard continues to exert pressure on its Japanese target Seven & I, the owner of 7/11 convenience stores. It is both unusual and commendable to see a Canadian global champion asserting dominance rather than the more traditional scenario of Canadian companies being acquired. Next week marks the beginning of Canadian Q3 reporting with key industries such as rails, large miners, Waste Connections and Rogers Communications all set to release results.

What to watch in markets next week

The aforementioned BoC rate decision on Wednesday will highlight the data calendar in Canada next week. We’ll also get the retail sales figure for August. The US is filled with more tertiary data, including the leading index, existing and new home sales, durable goods orders and the University of Michigan Sentiment Index.

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

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