Pause before pivot

Patrick O’Toole, Adam Ditkofsky and Pablo Martinez - 12/02/2022

Economic data

Fed Chair Powell spoke this week, and while he took pains to remind investors that the Fed is not done raising rates, investors took great comfort in his guidance for a step-down in the pace of rate hikes starting this month. That’s nothing new, so the reaction was somewhat strange as stocks soared and yields plunged. Investors are looking for any glimmer of hope that rate hikes are nearing the end, setting the stage for the Fed to pause rate hikes before pivoting to rate cuts at some point in 2023.

While the Fed’s work isn’t done yet, there is ammunition for it to ease off the brakes somewhat. The Job Openings and Labor Turnover Survey (JOLTS) report still shows that there are about two jobs available for every unemployed worker, but there were less people quitting for greener pastures, layoffs increased, hires fell, and overall job openings contracted and are down more than 1 million since February. That said, today’s employment report from the Bureau of Labor Statistics (BLS) did show greater than expected gains in new jobs, led by hiring in the Leisure and Hospitality sector. The Fed won’t like that hourly earnings picked up the pace. However, the household survey showed job losses for the 2nd straight month. We should remember that the BLS report is a lagging indicator, and generally only turns to job losses once the recession is well in hand, and that the household survey tends to call turns in the job market better than the BLS report. The housing market continued to show signs of stress as pending home sales – the leading indicator for the housing market – dipped for the 5th consecutive month and are down 36.7% year/year. That’s HUGE! Consumers sure are paying attention: confidence levels hit a 4-month low as they feel the negative wealth effect from softer home sales and home prices, with the latter in decline in September for the 3rd straight month as noted by S&P CoreLogic. The business outlook also took a hit as the Institute for Supply Management’s (ISM) survey of purchasing managers fell below the expansion/contraction level of 50. The good news is that prices paid and deliveries also declined, a good omen for lower inflation in coming months.

In Canada, GDP came in pretty much as expected in September, leaving growth in the economy up a healthy 2.9% annual rate in the 3rd quarter. The quarter saw a big contribution from government spending, but domestic demand actually contracted. As in the U.S., that’s likely a result of the negative wealth effect from falling home prices that damages consumer psychology (you’re NOT richer than you think). And the job market posted another gain, although modest. With wage gains slowing, the Bank of Canada may opt for only a 0.25% hike at its meeting next week.

Bond market reaction

It was a good month for bonds in November, capped by another rally this week. Longer-term bond yields have moved lower as the rate hike cycle nears the end, with the severe inversion of the yield curve pointing to a recession in 2023. Expectations for a recession aren’t translating to higher credit spreads, however. The rise in yields and in credit spreads this year have left investors comfortable increasing exposure to corporate bonds as they capture yields in the 5-7% area for investment grade bonds, and higher yet for high yield bonds.

Stock market reaction

Technology, materials and industrials drove another strong week for Canadian equities on the back of a more optimistic consumer, signs of less aggressive central banks, and a weaker U.S. dollar. This backdrop was specifically good for gold, which reached $1,800/oz. The two worst sectors this week were the ‘news-heavy’ energy and financials sectors. First in energy: TC Energy disappointed investors as they warned of higher capital costs at their Coastal GasLink pipeline; Enbridge bumped their dividend 3.2% and met expectations at their investor day; Suncor maintained the status quo with their update on retail stations but provided a modestly negative production update; and Canadian Natural Resources delivered the most positive update at their investor day, providing clarity on their return of capital plans and green house gas (GHG) reduction targets. The banks also wrapped up reporting with TD earning top marks, BMO and Royal next in line, followed by National Bank and Scotia, with CIBC delivering the most disappointing quarter and outlook. Royal Bank also announced an all cash $13.5 billion acquisition of HSBC Canada that the market took in stride.

What to watch next week

The Bank of Canada meets next week, and is expected to hike rates by 0.25% or 0.50%. We’ll also get the latest trade report and building permits numbers. The U.S. releases the trade report and data on factory orders, productivity, unit labour costs and producer prices.

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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