Feel the burn!

By: Patrick O’Toole, Adam Ditkofsky and Pablo Martinez

Economic data

You know that feeling when you’ve been dieting and working out for months, and you finally start noticing results? That’s likely how central bankers are feeling right now, as we see some softness in the economic data and on-going cooling in inflation. But just like any diet, the danger is always letting up too quickly and watching all your efforts wither away. We are still likely in the early days of seeing economic activity cool and inflation is still well above the Fed’s 2% target, but markets are already salivating over the notion that central banks are close to the end of their tightening cycles. Historically, the Fed has started cutting rates on average about 6 months after its last hike, consistent with the notion that monetary tightening generally causes something in the market to break. But as has been communicated, we’ll likely see rates elevated for some time. Of course, the danger remains that central banks push too hard, forcing them to reverse course by cutting rates prematurely, and thus risk losing the benefit of all their hard-earned results. Funny enough, this still sounds a lot like a diet and exercise plan.?

Canadian inflation continued its steep decent in March, coming in at 4.3%, down from 5.2% in February. Lower energy prices were the main driver for the decline, and while food inflation did slow on a month-over-month basis, it remains elevated at nearly 9% year over year. A large driver remains mortgage interest costs—no surprise given the sharp rise in mortgage rates—so it should make sense to remove this number when assessing economic implications. According to David Rosenberg, the seasonally adjusted consumer price index (CPI), excluding mortgage interest costs, rose by only 0.1% in March and is running at a pace of 1.9% over the past 6?months. So, it seems efforts to cool inflation are working, with further progress expected in the near term as some of the largest monthly price increases of 2022 drop out of the calculation. We also saw wholesale trade and retail sales for February and housing starts for March, all of which were softer than expected.?

U.S. data was fairly light this week, however we did see the leading indicator index for March decline by 1.2%, well below expectations of -0.7%. We also saw the Philadelphia Fed Business Outlook fall to -31.3%—a cautionary level, as this indicator has been this low only during recessions, 100% of the time going back to the 1960s! Lastly, weekly jobless claims also came in worse than expected at 245,000, representing the 7th consecutive week above 225,000. The rise in claims should be indicative of weaker payroll data in the months ahead.?

Bond market reaction

Bond yields moved lower on the week, partially reflecting ongoing weakness in economic data and increased expectations that central bank tightening would soon be coming to an end. The question remains how long rates remain elevated before any cuts are justified. Currently, the markets expect at least 6 months, but as we’ve been warning these expectations have been extremely volatile and could change quickly should market conditions evolve in either direction. Corporate bond spreads were stable this week, despite the unfavorable tone in data. RBC brought the first notable bank senior debt deal to Canada since January, and while the deal was well received, significant upscaling of its size and limited new issue concession caused the transaction to perform poorly once it started trading in the secondary market. Expectations for further bank issuance remains, but any additional transactions will likely need to come with larger concessions to attract buyers. ?

Stock market reaction

Equity markets struggled for direction this week, with the S&P/TSX once again outpacing U.S. indices despite being dragged lower by underperformance in the energy and materials sectors. The source of investor angst is the notion that interest rates may prove to be stickier at higher levels, which could choke off consumer demand and expedite economic contraction. In corporate news, TD Bank shrugged off overhyped headlines about being the most shorted bank in the world, and instead ended the week higher following Charles Schwab and First National Bank’s results not being as bad as feared. While TD noted that they were opening discussions with First Horizon on deal extensions, it can only be speculated that they will be renegotiating the target price lower. Elon Musk did not have as great a week, with Tesla dropping over 10%, SpaceX suffering a “rapid unscheduled disassembly”, and Twitter… well, just being Twitter. And finally, Teck Resources continues to generate the most newsworthy headlines given their boardroom battle with Glencore. While Glencore has stated that they will only increase their offer price for Teck Resources if the board engages in constructive discussions, Teck insists that their proposed separation of their coal assets is the best option for existing shareholders.?

What to watch next week

Next week in Canada we get GDP for February and the Canadian Federation of Independent Business’ (CFIB) Business Barometer for April. In the U.S. we’ll see Q1 GDP, personal consumption expenditures (PCE), Case Shiller housing data, new home sales, Conference Board Consumer Confidence, durable goods orders and both wholesale and retail inventories.

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Patrick O’Toole is Senior Portfolio Manager, Global Fixed Income; Adam Ditkofsky is Senior Portfolio Manager, Global Fixed Income; and Pablo Martinez is Portfolio Manager, Global Fixed Income.

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