A dot plot twist

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

Economic data

The Federal Reserve took centre stage again this week, but not because of the decision to keep the US policy rate unchanged at 5.25%-5.50%, just their second pause this year. Rather, it was the accompanying updated Summary of Economic Projections (SEP) and changes in the famed “dot plot” that caught the market’s attention. Most notably, Fed members slashed their call from pricing in four rate cuts in 2024 to just two, as well as forecasting less monetary easing to come in 2025. That decision is largely based on upgraded growth and employment projections, plus the expectation that inflation will only return to its 2% target by the end of 2026. The dots paint a clear picture – Fed participants believe the current level of restrictive rates is needed for longer in order to reach that elusive inflation target. Fed Chair Powell did his part in conveying that message and walking the tightrope between the risks of over- and under-tightening in his presser, even if he may be leaning a little too close to the soft landing camp. What we should remind ourselves is that these updated forecasts are in fact just forecasts and do require interpreting with some caution. Recall, just in March in the midst of the US regional banking crisis, when rate path expectations were changing rapidly. All it takes is another crack, and then, as we’ve noted before, forecasting looks more like an art than a science.?

The Bank of Canada (BoC) continues to deal with its own inflation conundrum, made more difficult this week thanks to another hot inflation report. August headline consumer price index (CPI) advanced +0.4% month over month, exceeding consensus by two ticks, and bringing the annual rate to 4.0% year over year. The market appeared better prepared for an upside surprise, with commodity prices beginning their upward climb last month. Yet, what’s more concerning to policymakers and investors is the acceleration in core inflation. On that, the average of the BoC’s core trim and median CPI figures also came in above expectations, rising to 4.0% from 3.65% on higher shelter costs. That fact brought another potential rate hike into play with futures markets pricing in an additional quarter point hike by early 2024. Interestingly, Deputy Governor Kozicki delivered a pre-arranged speech after the CPI print on Tuesday. In it, she emphasized how current policy tightening to date is already showing evidence of working. That’s fair, especially considering Q2’s dismal annualized GDP print, not to mention the string of weak national per capita growth rates. And it’s also fair to expect rates will continue doing their part in slowing inflation and activity, particularly as more mortgages come up for renewal over the next two years. As it stands today though, CPI is still running above the BoC’s target, and the August inflation report didn’t help. Fortunately, there’s still quite a bit of key data to digest before the next rate decision in late October, including July GDP, September employment, and another CPI report. The BoC hopes it helps steer the way ahead, one way or another.?

Bond market reaction

Canadian and US bond markets reacted sharply to the economic data this week, with yields reaching new cycle highs across a number of benchmark tenors. The 10-year Treasury cleared 4.45% on Thursday, a level last seen in 2007, while the 10-year Canada government bond pierced through 3.95%, which also marks a post-Great Financial Crisis high. Both North American yield curves were quite volatile, initially flattening in response to the Fed forecast, but then renewing their steepening on Thursday. Corporate bond spreads remain resilient despite that volatility and a healthy supply calendar. Canadian corporate investment grade new issuance is tracking over $12 billion this month, already outpacing the past 3-year September average of $10 billion.?

Stock market reaction

There was nothing pretty about this past week for stocks. Canadian equities experienced their largest weekly decline in over a year, and US equities experienced their largest weekly outflows since December 2022. All eleven Global Industry Classification Standard (GICS) sectors were squarely in the red, led by declines in technology, healthcare and utilities. Not even energy stocks could escape the declines despite West Texas Intermediate (WTI) prices continuing to trade through $90 per barrel. This carnage can be blamed on the hawkish pause by the Fed, and the prospects for “higher-for-longer” interest rates. The effects of this change can be seen in higher borrowing costs for corporations, less demand from the consumer, and lower valuation multiples for stocks given the higher discount rate. The select few Canadian listed stocks that were up on the week, including Trisura and Fairfax Financial, all show a collection of good growth prospects, strong pricing power, low debt levels and inexpensive valuations. This rare combination sums up the characteristics needed to overcome this current high-inflation, high-rate and slowing-growth environment. In corporate news, Brookfield wrapped up their affiliates investor day which included impressive updates from Brookfield Infrastructure, Brookfield Renewables and Brookfield Business Partners. While it was a tough week for the group’s individual stock prices, they all delivered an impressive message of above-target growth and extremely favourable positioning for all the opportunities presented by current market disruptions.?

What to watch next week

The July GDP report mentioned above headlines what is otherwise a quiet week for Canadian data. The US sees updated numbers on new home sales, durable goods orders, and personal income and spending.

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 Associate Portfolio Manager, Global Fixed Income; Craig Jerusalim is Executive Director and Portfolio Manager, Equities; and Rahul Bhambhani is Portfolio Manager, Global Equities.

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