Down to the Core

It’s been a rollercoaster ride for investors this month. Last week’s hotter than anticipated US Consumer Price Index (CPI) number caused many to contemplate the imminent rate cut expectations priced into the market — expectations that we’ve been pushing against since the start of this year. Despite our country’s more sluggish economic performance relative to the US, it was fair to be somewhat fearful ahead of the mirroring Canadian inflation release earlier this week. Yet, any notion of a similar upside surprise proved wrong with January headline CPI landing at 2.9% Year-over-Year (Y/Y). This was the lowest read since June 2023 and importantly once again within the Bank of Canada’s (BoC) 1%-3% target control range.

Economic data

Beyond travel and transportation related categories (which were casualties of a more indebted consumer) the decline in energy prices was a key detractor, falling 1.1% Month-over-Month (M/M) and gas fell by 0.9% M/M. That’s why when looking at the less volatile core inflation figure (which excludes food and energy) the progress appears less substantial.?

Median core-CPI is still treading in the mid-to-3% area, a little high for the BoC’s liking, although it did decline a few ticks from December 2023. The more positive spin is that the breadth of price pressures is clearly easing. For instance, less than 50% of the inflation basket is accelerating by more than 3% —the first time that’s been the case since late 2021. Unfortunately, concerns regarding stubborn services and shelter inflation, currently 4.2% and 6.2% Y/Y respectively, have not abated. The gap between the latter and headline CPI is now at the widest level since the early 1980s. Nonetheless, the downside surprise sent Canadian bond yields plunging, with the market now pricing in the first BoC rate cut in July. While the timing makes more sense versus where we started the year, Governor Macklem is likely looking for a bit more progress on the core figure before feeling comfortable moving rates to a less restrictive level.

It was a cheery holiday season for the Canadian consumer as December retail sales advanced 0.9% M/M. Auto sales were the notable outperformer, but the report as a whole was solid given that volumes were up 0.8% M/M. The bad news is that the flash estimate for January suggests a decline of 0.4%, though the initial read is often subject to revisions.

On the US side, economic releases played second fiddle to earnings this week, minus a peak into the US Federal Reserve’s (the Fed) thinking from the latest Federal Open Market Committee (FOMC) meeting minutes. Albeit slightly outdated, more Fed officials expressed unease about cutting interest rates too quickly.? That’s consistent with Chair Powell’s comments to the media following the meeting last month, yet the futures market still sees the first cut coming in June.

Bond market reaction: A rare divergence

A rare divergence in bond yields occurred this week as Canadian rates outperformed and moved lower on the back of the CPI print. US yields continued their march higher as the US 10-year moved above 4.30% for the first time since November 2023, all but reversing the significant rally we saw at the end of 2023. Again, that’s a function of resilient US growth and more hawkish comments out of the Fed.? Credit spreads continue to grind tighter under the positive growth backdrop as investors welcomed higher all-in yields. Primary supply also recently picked up quite a bit and continues to be well-absorbed.

Stock market reaction: Global equities at all-time highs

This holiday shortened week was one for global equity markets crashing through all-time highs. In addition to the Nasdaq, S&P500 and Dow Jones Industrial Average, many European indices and even the much belated Japanese Nikkei managed to reclaim its all-time high not experienced since the late 1980s.

The recent surge by global equities owes much of its strength to the results of Nvidia and the AI fueled growth frenzy. In the company’s own words, the world has “reached the tipping point of new computing era.” And before the bears start warning about imminent doom and 1999 comparisons, the US$274 billion wealth created by Nvidia on Thursday (February 22, 2024) alone and the 60% surge in its stock price this year is more than matched by their earnings growth. This effectively lowered its valuation multiple and justified much of the impressive rally.

One benchmark yet to reclaim its all-time high reached in early 2022 is the S&P/TSX. While the commodity heavy TSX does not boast the likes of the Magnificent 7, there are many underappreciated areas of AI growth hidden in plain sight, including companies with direct exposure like Shopify, Thomson Reuters and Docebo. There are also indirect beneficiaries like Kinaxis, Dye & Durham and CGI as well as companies benefiting from massive infrastructure and power requirements of AI including the Brookfield group of companies. All to say, the 22100 level for the TSX is not out of reach, but it will get there a lot faster if oil can get back above US$80 per barrel.

What to watch in markets next week

The only notable data release in Canada next week is December GDP and the corresponding read for the fourth quarter as a whole. The US will see a host of data with new home sales, durable goods orders, personal income and spending along with another key inflation measure, the PCE deflator, arriving on leap day.

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

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