Let the good times roll

It’s a recurring practice this time of year for market prognosticators and strategists to release their annual outlooks. The brave among them may actually revisit their predictions from a year ago to see where they landed. However, for those looking at last year’s set, spoiler alert, don’t expect top marks.

The well-known reason being that at this time last year, an impending recession permeated through the pages of most outlooks. Those calls seemed reasonable at the time. In fact, the US Federal Reserve (the Fed) and Bank of Canada (BoC) were only 400 basis points (bps) through their tightening cycles at the time. And the follow on impacts were expected to begin to be felt in 2023. There are reasons why the economy has withstood that policy tightening to date. These reasons include a less interest sensitive US consumer, buoyant labour markets, strong fiscal stimulus on both sides of the border and mostly clean corporate balance sheets. But of course, hindsight is 20/20.

Economic data

Now as we look towards 2024, investors are left pondering whether the October US CPI report released earlier this week marks a true inflection point in the inflation story. Ultimately, is it enough to let the good times roll? The report showed CPI coming in lower than expectations at 3.2% year-over-year (YoY) from the prior3.7% —and markets reacted. It sent bond yields plunging, the futures market priced out any further rate hikes from the Fed and risk assets ripped higher. What got the market really excited were the details of the report. Core CPI fell to 4.0% YoY —the lowest since the summer of 2021. The Fed closely watched core services measure decelerated to 0.3% month-over-month (MoM) —largely owing to lower shelter inflation. Goods inflation remained soft as well, as recent supply chain disruptions are all but a thing of the past.

All to say, the market is now running with the idea that the Fed has enough evidence to pause rate hikes for the time being and assess how the economy evolves as we head into next year. Nonetheless, we’ll again caution that although the trend is moving in the right direction on inflation, we’re still above Fed’s target rates of 2%. Moreover, it’s still quite possible that the lagged effects from policy tightening may actually begin to bite further next year, challenging the notion that the Fed has successfully engineered its desired “soft” or “no” landing outcome. So don’t be surprised if Fed officials continue to talk tough in order to prevent financial conditions from becoming too loose and perhaps jittering markets in the process.

The Canadian economic calendar was light this week. Existing home sales data for October certainly showed how our housing market is reacting to the BoC’s own rate hiking cycle. Monthly sales fell by 5.6%. This represents the largest decline since June 2022 with weakness seen across the country. The structure of our mortgage market and the more interest rate sensitive nature of the Canadian consumer are major reasons why the BoC is likely on hold rates in the near-term.

Bond market reaction: Yields were down

As mentioned, the US CPI report was the main culprit in moving bond yields this week. The benchmark US and Canada 10-year bonds are poised to close about 20 bps lower, with the majority of the move occurring after the inflation data was released on Tuesday. That continues what’s been a very volatile time in both markets, with those same benchmark bonds declining almost 50 bps since October 31, 2023.

Corporate bond spreads haven’t seen nearly the same level of volatility. Although they did modestly tighten this week with the risk-on tone. New issues were also topical with corporate treasury teams taking advantage of the decline in all-in yields. New issues have generally performed well in secondary trading.

Stock market reaction: Equities were up

Even as weaker economic signposts around inflation and a slowing consumer unfolded this week, equity markets rocketed higher on the prospects that the end of the current tightening cycle is upon us. The gains were led by the most beaten-down yield stocks and small caps that cheered the prospects of lower interest rates —likely also aided by a little short covering.

The only sectors that were in red and reflected the consumer slowdown were energy and consumer staples. Energy stocks were led lower by the price of oil, as West Texas Intermediate (WTI) dropped to its lowest level in four months before rebounding this morning. Demand concerns are likely over blown, given emerging market strength is more than offsetting any domestic market weakness. Global oil inventories are still at extreme lows.

In corporate news, Teck Resources finally announced the divestiture of their metallurgical coal assets for over US$9 billion to Glencore. While the initial market reaction was quite muted, the sale does position Teck as a rare pure-play copper growth stock with an extremely strong financial position that is operating in the best mining jurisdictions globally.

What to watch for next week

In Canada, the spotlight will be on the release of October CPI and September retail sales. Investors should also be closely watching the Federal Government’s Fall Economic Statement on Tuesday, November 21, 2023. The US will see a host of tertiary data during the shortened week (due to Thanksgiving), including the leading economic index, existing home sales, FOMC meeting minutes and durable goods orders.

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

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