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Patrick O’Toole, Adam Ditkofsky and Pablo Martinez - 01/27/2023

Economic data

The Bank of Canada hiked its rate another 0.25% this week, taking its rate to 4.50%. While the Bank is leading us to expect that it will be on hold for a while, (“now it’s time to pause and assess…”), it’s generally not a good idea to make a firm commitment about its future plans. Central banks like to leave their options open, as they should, and the Bank could decide to hike more in coming months should inflation and/or the labour market not behave as it hopes. Indeed, Governor Macklem said that the pause is a “conditional pause”, and that the Bank “is prepared to increase the policy rate further if needed to return inflation to the 2% target.” But the Bank could just as easily move to ease rates later in 2023, as the futures markets continue to forecast. After all, historically, central banks have cut rates within a few quarters of the last rate hike, given that their rate hikes have led to recessions or other problems that require a pivot. And a cut in rates in the second half of 2023 wouldn’t necessarily mean the Bank is moving to easier conditions. Instead, it would mean conditions are just less restrictive.

In the U.S., we could see the Fed pause after its next expected rate increase on February 1. There is still some debate as to whether the Fed hikes by 0.25% or 0.5% (the futures markets see 0.25%), given the varied takes on recent data releases. GDP for Q4’22 showed an economy holding up well. But the details showed that strength was largely attributable to a build-up in inventories (that doesn’t bode well for coming quarters as those elevated inventories are pared down), and to still buoyant consumer spending. There is growing evidence that growth is slowing further into 2023, raising the risks that GDP could contract in the current quarter. That evidence was seen in the durable goods report that, while still positive, was skewed by airplane orders. Excluding that volatile component, durable goods declined month/month and the core shipments component was also negative. New home sales bounced a little bit, however that was after a big downward revision to the prior release. Regardless, 2022 saw the smallest annual total home sales in four years, with the impact of higher mortgage rates. There was also strong evidence from the leading indicators, that showed a 10th consecutive monthly decline, and they have fallen to levels that, in the history of this measure going back to 1959, a recession has always followed. Personal income and spending data are moderating too. And the Fed’s favoured inflation measure, the Personal Consumption Expenditures Deflator (PCE Deflator), also moderated, with the core deflator at 4.4% year/year. It was 5.4% at its peak last February.

Bond market reaction

The bond market lost a bit of ground on the week, with long-term yields rising modestly, while short-term yields followed suit after the Bank of Canada provided no real surprises. The futures markets still expect to see the Bank and Fed cutting rates in the second half of the year, despite the pushback from both central banks on such an eventuality. While that seems like a stretch at the moment, inflation is poised to drop sharply in the next 6 months, and the decline could be exacerbated if, and when, we see a recession, providing cover for an easing on the brakes by the Bank and Fed.

The corporate bond market is open for business as investors that sold late last year for tax-loss selling reasons are returning to the market. Corporate spreads narrowed marginally, although Canada’s market has lagged the stronger moves seen in the U.S. and Europe.

Stock market reaction

Equity markets continued their impressive march higher this week, despite a less than spectacular start to the fourth quarter earnings season. The S&P/TSX is now up 7% year-to-date, and is even up 4% on a year-over-year basis. However, the “January Effect” may not be prophetic of moves to come, given the cautious tone from many bellwethers reporting this week, on-going announcements of job cuts, and the lagged effect of higher interest rates. The top performing sector on the TSX this week was technology, led in large part by big price increases from Shopify that boosted its share price to a 9-month high, albeit still 70% below its all-time-high, but a nice rally nonetheless. The Rogers/Shaw merger appears to be coming to an amical conclusion as the Canadian Competition Bureau announced they won’t pursue further appeals. And we saw two top-tier CEOs announce their departures from Element Fleet and Neighbourly Pharmacy. While both are leaving big shoes to fill, each company has found excellent choices for their replacements. Laura Dottori-Attanasio from CIBC will be taking over at Element, and Skip Bourdo joins Neighbourly with nearly 30 years of experience at Walgreens and Athletico. Next week, we will get earnings announcements from Canadian Pacific, Suncor, BCE and Rogers, as well as Alphabet, Apple and Amazon.

What to watch next week

Canada’s GDP report for November will be released next week, along with building permit numbers. The U.S. will release the employment cost index, consumer confidence, purchasing manager surveys, the Job Openings and Labor Turnover Survey (JOLTS) report, unit labour costs, auto sales, and the employment report. The Fed is also expected to hike its rate again.

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Disclaimer

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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