Is this the end of central bank policy rate increases?

Investors began debating the notion that central banks may be done raising policy rates this week. This followed the release of last month’s lackluster jobs data (released last Friday). It’s also on back of both the Bank of Canada (BoC) and the US Federal Reserve’s (the Fed) decisions to leave rates unchanged at their last policy meetings in October and early November. The view that policy rate hikes may be done continued to strengthen as softer data was released this week, with bond yields moving lower and again pushing the Canadian bond market back into positive territory for the year.

Futures markets are once again pricing in rate cuts within 1-years’ time, similar to expectations seen last summer. Markets are now pricing in 0.50% in rate cuts for both the US and Canada. However, we can’t forget that futures markets have been extremely volatile this year, especially in the context of trying to predict how central banks will react over the coming months. Interpretations of what’s priced into the market at any given time should be taken with caution.

Investors should not discount that inflation still remains above central bank target levels of 2%. This implies policymakers still have work to do. Although material progress has been made in getting inflation down to its current level of 3%-4%, both the BoC and the Fed are committed to bringing inflation down to its target rate of 2%. So unfortunately, we see the move this week as the market getting ahead of itself, with bond yields at risk of retracing their previous peak levels.

Comments from both central banks remain hawkish, with policymakers continuing to warn that further hikes may be needed, especially if inflation re-accelerates. Efforts by the Fed to continue shrinking its balance sheets (quantitative tightening) while federal deficits aggressively grow, could also put further upward pressure on bond yields.

While progress has been made with slowing Canadian economic activity, we can’t ignore the on-going resilience of the US consumer. InQ3, we saw S&P 500 profits turn positive for the first time this year. So, while there are positive signs that central bank efforts are working, risks to the upside in rates remain. At this juncture, it seems too soon to make the call that we’re at the end of this rate hiking cycle— but that doesn’t mean we aren’t close to the end. Our expectation is for inflation to further ease gradually. This implies policy rates need to stay elevated for some time.

Economic data: Stats were light this week

In Canada, the September merchandise trade balance exceeded expectations due to stronger exports to the US driven by energy. However, building permits were down 6.5% with greater than expected weakness seen in the non-residential sector.

In the US, consumer credit rose to USD$9 billion in September, but this is a far cry from the increases we saw in 2022.? Wholesale inventories and sales did come in slightly higher than expected. Sales in the automotive and non-durable goods were elevated, bringing the inventory/sales ratio down to a more normalized level of 1.33.??

Bond market reaction: Yields are down

Bond yields were lower this week following last Friday’s soft labour data. This brings yields down from their peak in mid-October. For context, the US 10-year yield fell from a high of 5.0% to a low of 4.5%.

Yields have since moved modestly higher, with part of the volatility being attributed to short covering. Still, corporate bond issuers took advantage of lower interest rates, with multiple investment-grade and high-yield transactions coming to market. Given the lack of new corporate supply over the past month, demand for corporate bonds was strong with most being well oversubscribed and performing well in secondary markets.

Stock market reaction: Continuing their relief rally

Equity markets continued their relief rally globally with Japan leading the charge. The Japanese market continues to be one of the best performing global markets, alongside the Nasdaq. However, for Canadian investors that hasn’t yielded an impressive return given the Yen has depreciated by nearly 13%.

In North America, earnings season continues with most companies reporting decent results despite warnings about macro uncertainty. Intact Financial reported good earnings and pointed to a normalization in claims inflation, down from double-digits last year to only 5% this quarter. However, consumers may not be in the clear as the company plans to continue increasing prices to expand operating margins.

In fintech, Adyen unveiled new mid-term targets that took investors by surprise. Over the past year, Adyen has struggled with moderating growth levels following an exceptional period of sales thanks to strong ecommerce and online shopping. The company still plans to grow sales by more than 25% and hit 50% EBITDA margins, despite increasing competition in the industry. While Adyen’s growth numbers are nothing to scoff at, this serves as a friendly reminder that valuation of companies does matter.

What to watch for next week

In Canada, we’ll see wholesale and manufacturing sales, housing starts, existing home sales and international securities transactions. In the US, we’ll get the monthly budget statement for October, the NY Fed 1-year inflation expectations, the NFIB small business optimism survey, CPI, PPI, import and export price indices and retail sales.?The views expressed in this document are the views of CIBC Asset Management Inc. and are subject to change at any time. CIBC Asset Management Inc. does not undertake any obligation or responsibility to update such opinions. Certain information that we have provided to you may constitute “forward-looking” statements. These statements involve known and unknown risks, uncertainties and other factors that may cause the actual results or achievements to be materially different than the results, performance or achievements expressed or implied in the forward-looking statements.

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

This document is provided for general informational purposes only and does not constitute financial, investment, tax, legal or accounting advice nor does it constitute an offer or solicitation to buy or sell any securities referred to. Individual circumstances and current events are critical to sound investment planning; anyone wishing to act on this article should consult with his or her advisor. All opinions and estimates expressed in this document are as of the date of publication unless otherwise indicated, and are subject to change with the exception of bond data, which is as of end of day the previous Thursday, and equity data, which is as of mid-day Friday.

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