The juice is worth the squeeze

It looks like US Federal Reserve (Fed) Chairman Powell can finally go on his long overdue summer vacation this weekend as markets are finally starting to acknowledge further progress with cooling inflation. This week’s consumer price index (CPI) print for June came in below expectations at -0.1% Month-over-Month (M/M), making it 3.0% Year-over-Year (Y/Y). This in combination with last month’s soft jobs data is supportive of future markets to again price in rate cuts in Q3. Markets are now pricing in a 90% probability of a rate cut in September. That’s a big difference from the end of June when the market was only pricing in the first rate cut in November.

Overall, recent economic releases are coming in a lot softer than expected, with the Citi Economic Surprise Index dropping to a low of -48.0 in July, representing its lowest level in almost two years. So, this should provide Chairman Powell with a sigh of relief and allow him to kick up his feet and sip his favourite cocktail this weekend. But we don’t recommend he get too comfortable. While some progress is encouraging, the September meeting is still a few months away. From now until then, there are a few data points that could sour market expectations.

Looking ahead, the Fed’s next policy rate decision is scheduled for July 31, 2024 and while we don’t expect any change at that meeting, we do expect the Fed’s press release to include comments that signal a potential rate cut in September (provided data remains supportive). Still, this week’s data gave investors’ confidence to celebrate with both risk assets and rate markets reacting positively.?

Economic data

Looking at June’s -0.1% CPI print in greater detail, there are a lot of points to highlight. First, core CPI fell from 3.4% to 3.3%, reflecting the M/M increase in shelter falling from 0.4% in May to 0.2% in June. This represents the first decline since January 2024. Hopefully, this is a sign of further progress to come in the second half of 2024, but any further progress with shelter inflation will likely be gradual. Second, core CPI (excluding shelter) fell to 1.8% Y/Y in June, representing its lowest level since March 2021. It’s also worth noting this data point has been stable at approximately 2.0% for close to a year. This tells us that in aggregate, inflation for discretionary goods and services has been stable for some time. Finally, transportation services, which represent the bulk of the service category excluding shelter, fell for the second straight month by 0.5% —airline fares plunged by 5.0% in June alone! While auto insurance did re-accelerate to an increase of 0.9% M/M, it’s well below levels seen earlier in the year. The outlook for this category is critical to the Fed achieving a 2% target inflation rate on a sustained basis. We feel this is reasonable given it’s unsustainable for auto insurance prices to continue to rise by 19% Y/Y.?

In other news, it appears that President Biden continues to face hurdles with his candidacy, with celebrity donor George Clooney now calling for him to drop out of the race. Behind the scenes there are even rumors of dissent from former President Obama and Nancy Pelosi. The next few weeks will be very interesting on the political front.?

Bond market reaction: Moved lower

Bond yields moved lower on the week, supported by weaker than expected inflation data and further supported by Fed Chairman Powell’s dovish testimony to the Senate Banking Committee. The yield curve, defined as the difference in yield between 2-year and 30-year government of Canada bonds, was modestly steeper as the move lower in yields was more pronounced in shorter dated bonds.

Futures markets are now pricing in a 90% probability for a rate cut by the Fed in September, while expectations for a second rate cut by the Bank of Canada (BoC) are close to a 70% probability in July. Corporate bonds continued to perform well this week, with both investment grade and high yield credit spreads modestly tightening. New issues continue to perform well with demand outpacing supply.?

Stock market reaction: Gained this week

The S&P500 snapped seven days in a row of gains on Thursday, despite very supportive inflation and employment prints. The broad US benchmark is still up an impressive 17% this year and is virtually sitting at its all-time record high. The more cyclically sensitive S&P/TSX had an even more impressive week, advancing over 2% to exceed its all-time record high on the back of strong commodities, financials and interest-rate sensitive sectors.

Second quarter earnings kick off next week in the US with an emerging trend of breadth starting to break out. So far this year, the magnificent 7 stocks plus Eli Lilly accounted for over 70% of the S&P500’s return. However, the remaining 492 stocks are looking to play some catch-up. In fact, the bottom 492 stocks in the S&P500 are expected to show positive earnings growth this quarter for the first time in six quarters.

What to watch in markets next week

Next week we’ll be watching the large US banks kick off second quarter earnings for further signs of consumer and economic stress or see if this impressive rally can continue. In the US. we’ll also see import and export price indices, business inventories, building permits and housing starts, industrial production, capacity utilization, the leading index and total net TIC flows.

In Canada, we’ll get a lot of data including manufacturing sales, wholesale sales, the BoC Business Outlook Survey, housing starts, CPI and retail sales.??

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

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