Foreshock

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

Economic data

Geography classes are probably buried far away in our occipital lobe, but it would be useful to open some old textbooks and review the concept of foreshock, which can be defined as mild tremors preceding the violent shaking movement of an earthquake. This notion can be transposed to markets: financial earthquakes, like the one we lived through in the crisis of 2008, are often preceded by sporadic stresses of lower magnitude. This is why there is little solace to be found in the relative calmness of markets following two weeks of headlines dominated by bank failures and rescue plans. It is good news that central bankers have been able to contain the recent turmoil, but this is certainly not the last time we will be surprised by the unforeseen effects of this historic global rate hike campaign. This welcomed interlude has allowed us to focus on economic data. The third revision to Q4 U.S. GDP was released, and while the overall number came slightly below expectations at 4.6%, core personal consumption expenditures were revised higher to 4.4%. Looking deeper in the report, we noticed that pre-tax earnings have dropped by 18% on an annual basis, which does not bode well for future economic growth. Personal income and spending came out respectively at 0.2% and 0.3% monthly increases—yet more proof that the US consumer remains a positive contributor to GDP growth. Finally, the PCE deflator was slightly below expectations, but a 5% year over year number is still far away from the central bank’s target.

In Canada, news revolved around the federal budget this week and, once again, the Liberal government surprised with its ability to find new ways to spend taxpayer money. Normally, financial markets look beyond such news, but with the unemployment rate at historical lows and GDP growing at 3% on a year-over-year basis, a $40 billion deficit just adds fuel to the fire and works against the central bank’s goal of 2% inflation. If the government is willing to spend so much money when times are (relatively) good, how big of a hole will they dig if a recession hits?

Bond market reaction

Volatility in the bond market diminished as news about the banking system was slowly relegated to the back page. Ten-year Government of Canada rates settled at 2.92%—about 20 basis points higher than the closing of last week—as the flight-to-quality subsided. The yield curve resumed its flattening trend as the probability of central banks cutting rates was reduced in the absence of headline risk and resilient economic data.

Corporate spreads recovered some of the recent increase, but still remain wider compared to pre-SVB-failure levels. New issuers have been able to tap the market, but issues are coming with bigger concessions which reprice the secondary market cheaper.

Stock market reaction

It was a week of green across global equity markets, while signs of stress are growing in the commercial real estate (CRE) market. Warning signs of the past year are becoming more apparent as investors dig deeper into all aspects that can affect regional banks, especially in the United States where estimates suggest nearly 80% of CRE loans are originated at regional banks. So where does the issue lie? First and foremost, interest rates have taken a toll on property values, similar to other real estate subsegments. Next, office occupancy rates continue to struggle despite return-to-office mandates. This has led to reductions in rents in some cases as well. Lastly, given the regional bank scare in the U.S. over the last month, lending standards are starting to tighten. As a result, banks with CRE exposure and real estate investment trusts (REIT), globally, have been under pressure given aforementioned concerns. On a separate note, in China, Alibaba announced a restructuring that would result in six separate publicly listed companies, in an attempt to unlock shareholder value. Investors will now be able to pick their preferred business units whereas employees will have stock-based compensation that’s more aligned with their segment. Whether this actually unlocks value remains to be seen, but all eyes are on other large tech giants, to see if this becomes a new trend in technology.

What to watch next week

There will be a lot of data for economists to chew on next week, as data from the Institute for Supply Management (ISM) will be released, both for the manufacturing and service sectors in the U.S. We will also see if the downward trend in durable goods orders continues. But more importantly, both Canada and the U.S. will publish their respective employment numbers, which will allow us to see if all those layoff announcements finally result in a loosening of the job market.

Patrick O’Toole is Senior Portfolio Manager, Global Fixed Income

Adam Ditkofsky is Senior Portfolio Manager, Global Fixed Income

Pablo Martinez is Portfolio Manager, Global Fixed Income.

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