New year, same pressure?

Patrick O’Toole, Adam Ditkofsky and Pablo Martinez - 01/06/2023

Economic data

Happy new year to all as we head into an exciting 2023! As most of us are getting back to work after a much-deserved break, markets slowly emerged from the new year celebrations with the release of December’s Federal Reserve meeting minutes on Wednesday. While officials agreed that financial conditions have tightened, inflationary pressures remain too high. Even though inflation eased in the months of October and December, the Federal Open Market Committee remains of the opinion that it will take substantially more progress to be confident that inflation is on a sustained downward path. The central bank should be pleased to see that the manufacturing sector will likely not be contributing to higher prices as the Institute for Supply Management survey showed that the sector is in contraction territory, with a print of 48.4. The job market is telling another story though, as many indicators still show that employers are looking for help. The Automatic Data Processing employment change, initial jobless claims and the payroll numbers all printed higher-than-expected numbers. Payrolls in the U.S. came in at a higher-than-expected 223,000, bringing the unemployment rate to the multi-decade low of 3.5%. Strangely enough, even though jobs were plentiful in December, wage pressures have eased more than expected, with average hourly earnings showing a 4.6% increase on a year-over-year basis, 0.4% lower than expected. The same story is developing on this side of the border, where an astounding 104,000 jobs were created, taking the unemployment rate to 5%. The hourly wage rate came in at 5%, lower than the prior month, but still at elevated levels. While keeping in mind that monthly Canadian employment numbers are notoriously volatile, the trend remains positive for jobs in the country.

Bond market reaction

The market regained some of the ground lost last week, as 10-year Canada government bond yields dropped by 10 basis points to 3.19%, well within the range we have seen in the past few weeks. The strong Canadian employment report did raise the odds slightly that the Bank of Canada may hike another 0.25% at its January 25 meeting. The futures market now has the odds at 80% that the Bank acts again. The U.S. employment report, while showing some modest moderation in wages, is unlikely to sway the Fed from another 0.50% hike at its February 1 meeting.

Corporate and provincial bonds were under selling pressure after December’s stellar performance in spread products. Spreads did widen somewhat, but we should get a clearer picture as market liquidity returns to normal and corporations tap the market with new issues.

Stock market reaction

Global markets this week saw a sharp divergence by region, with the U.S. modestly negative after strong jobs data and fears of continued rate hikes. In short, U.S. markets have started off with the same playbook as 2022. Most European markets saw a strong start to the year as natural gas and energy prices reversed. Consumer sentiment was dented in the region stemming primarily from energy, so the recent reversal provides relief. Lastly, Chinese markets outperformed in Asia as its economy gears up for a reopening from covid-related restrictions. On a stock-specific level, Tesla stumbled with a -10% return this week. It has been providing clients with discounts, missed 2022 delivery forecasts, and recently got left out of a rebate program for the model Y. Next, while consumers are not strangers to food inflation, Lamb Weston, one of the largest manufacturers of French fries, raised prices nearly 30% last quarter! The massive price increase took investors by surprise and serves as a friendly reminder to double-check frozen fries prices at the grocery store next time.

What to watch next week

All eyes will be on the release of the December Consumer Price Index data next Thursday; markets are expecting further moderation in the pace of inflation, which could tame the Fed’s resolve to further tighten market conditions. Another important number will be the change in real average weekly earnings, as Chairman Powell mentioned many times his concern that rising wages can further fuel inflation.

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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