Life in the fast lane

The US economic engine is revving like a Ford GT40 at Le Mans. After a strong inflation number last week, retail sales roared passed expectations coming out at an astounding 0.7% for the month of March. The previous month was also revised up to 0.9% from 0.6%, making this performance even more surprising. The control group, which is used in the gross domestic product (GDP) calculations also showed strength at 1.1%. This should put upwards pressure on the 2.4% growth the Atlanta Fed was expecting for Q1. Sales numbers are being pushed higher by inflation, but even so, the US consumer is still firmly in the driver’s seat and the foot is on the gas pedal. The US Federal Reserve (the Fed) is taking note and told markets this week that an economy running at such speed doesn’t need a supercharger to make it go faster. Fed Chairman Powell said recent data indicated it would take longer than anticipated to achieve the level of confidence necessary to ease monetary policy. As expectations for rate cuts take a back seat, interest rate sensitive sectors are showing signs of weakness.

Economic data

Housing starts fell 14.7% to 1.32 million units this month, as builders remain cautious that a mortgage rate north of 7% will keep potential buyers on the sidelines. Furthermore, those who already own a home don’t want to exit from their low mortgage rates set during the pandemic, which helps explain the drop in existing home sales to 4.19 million units. We have to go back to the great financial crisis (GFC) to see such low levels of activity. Finally, after a one-month incursion in positive territory, leading indicators are back in the red at -0.3, dragged down in part by building permits and interest rates. There is a recurring theme here.

However, the Canadian economy has fewer ponies under the hood. Canadian inflation is slowing down at a speed that makes the Bank of Canada (BoC) increasingly confident that it will be able to provide the much anticipated boost it needs to avert a recession. The Consumer Price Index (CPI) for March came a bit lower than expected at 0.6%, taking the Year-over-Year (Y/Y) print to 2.9%. Core measures also came in below expectations and the share of components that are rising at a pace higher than 3% diminished to 38%. There are still hurdles to watch for in this report as service inflation came in at 0.5% for the month. This puts the yearly measure on an accelerating path at 4.5%. Nevertheless, this number alone should not be enough for the BoC to make a U-turn on its intention to ease policy.

Bond market reaction: Left in the dust

The bond market was left in the dust this week as strong consumer activity and hawkish talk from Fed officials took rates higher. The 10-year US Treasury bond got to the finish line at 4.61%, an increase of 9 basis points (bps). Canada’s move was less violent, but it’s worth noting that the 5-year yield, which drives mortgage rates, increased 8 bps to 3.78% —ad news as spring is prime time for housing activity. A constructive CPI, coupled with higher supply in the 10-year area helped the yield curve move steeper. Although corporate bond spreads around the world widened somewhat this week, Canadian corporate bonds remained stable helped by a relatively low number of issuers tapping the market.

Stock market reaction: Extended contraction

North American equities extended their longest and deepest contraction since last October. Despite it not feeling that way, we’re yet to reach even a 5% pullback from all-time record highs. Both US and Canadian benchmarks are still up approximately 5% Year-to-Date (YTD). ?The S&P/TSX is trading well below its long-term average price-to-earnings multiple, providing some downside valuation support.?There are many reasonable excuses for the pullback including sticky inflation, higher interest rates and geo-politics. However, it could also be some natural profit taking after a stunning and virtually unabated 30% rise since October.

US first quarter reporting kicked off in earnest this week with mixed results. Within financials, Goldman, Wells Fargo and Morgan Stanley all fared relatively well. This morning Netflix is indicated to be lower, despite exceeding subscriber estimates. Netflix advanced over 80% from its October lows and expectations for future growth likely got ahead of themself.?Most commodities were higher this week following US and UK sanctions on Russian metal production. Oil on the other hand, bounced around like a yo-yo and at times taking cues from the unexpected rise of US inventories, but then regaining a stronger bid on the back of flair ups of Middle East tensions. The latest on that complex issue seems to be a cooling of sorts as WTI currently sits a few dollars below its inter-week high.

What to watch in markets next week

The endurance race will continue next week as we’ll be getting the advanced reading of US first quarter GDP. We’ll also learn more on the health of the consumer with the personal income and spending numbers. Finally, the week ends on a high note with the PCE deflator.

Canada has a lighter calendar with retail sales and the SEPH payroll report. We’ll also be keeping an interested eye on the start of first quarter reporting, with Rogers, the rails, Teck Resources and Waste Connections all on the docket.

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

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