Politics: Hotter over the Weekend!

Several key developed economies are undergoing significant political changes this year. In France, a left-wing coalition secured a majority in the newly elected parliament during snap elections, surprising markets after the far-right National Rally, led by Marin Le Pen, initially led in the first round. This departure from France's usual political landscape, where a single party typically controls the majority and forms the government, has prompted a reassessment of market risks.

Similarly, the United Kingdom shifted leftward as Labour effectively ended the Conservative Party's 14-year rule. Across developed markets, the trend of incumbent losses reflects voter discontent with ruling parties, often blamed for post-COVID inflationary pressures.

In key emerging markets, a comparable pattern emerges, albeit with less dramatic shifts. Mexico saw Claudia Sheinbaum's election surpassing pre-election expectations. In India, Modi secured a third term, yet his party fell short of a majority, necessitating a coalition government. South Africa is also poised for a coalition government formation. Taiwan remains an outlier, with the Democratic Progressive Party winning a third consecutive term, suggesting continuity in policy.

The main event is yet to come in the United States. Trump's presidential prospects have risen following Biden's performance in the initial debate rounds. The Saturday shooting at Trump, a former president and current Republican candidate, may further sway voter preferences, drawing parallels with Reagan's popularity surge after an assassination attempt. (Source)

Markets are likely to continue positioning for the implications of a second Trump presidency. Trump's previous term was marked by lower taxes and pro-business policies alongside protectionism and higher tariffs on imports. While these measures could stimulate the US economy, they also pose inflationary risks. A stronger US economy could benefit Canada, yet continued tax cuts in the US might undermine Canadian competitiveness and economic growth. Increased protectionism could further challenge Canada's economic prospects.

Macroeconomic Update

Inflation: US CPI data came in last Thursday. Headline CPI was down 0.1% month-over-month, marking the first decline in four years, which means that the year-over-year number was 3.0%. Core CPI was at 3.3% year-over-year. A decrease in gasoline prices helped bring down the headline figure, along with decelerating shelter costs.

The inflation figures, combined with slowing employment growth, should help cement expectations of a September rate cut by the Fed. As we write, the markets currently price in one cut by the Fed on September 18, followed by another in December.

Employment: Canada recently released its employment figures, showing a muted change with a loss of 1.4k jobs. The unemployment rate increased to 6.4% in June from 6.2% in May, primarily due to significant population growth. Consequently, bond market yields fell at the front end of the curve. Year-over-year wage growth rose to 5.6% in June from 5.1% in May, mainly driven by collective bargaining efforts across various industries. The increase in the wage growth rate, coupled with rising unemployment and reducing lagging inflation, is a cause for concern.

US unemployment data also supports the rate cut narrative. First, there were substantial negative revisions to prior months' non-farm payrolls data. Combined with a step-up in unemployment to 4.1% (one notch above expectations) and slower wage growth (0.3% month-over-month in June vs. 0.4% in May), this should indicate that the labor market is no longer too strong for a rate cut.

GDP: GDP: For May, Statistics Canada indicated in its early estimates that the GDP added 0.1%, which is a material deceleration after 0.3% growth in April. Combined with employment data, this also supports further moves by the BoC. The markets do not fully price in one more cut by the Central Bank during the meeting on July 24, though the probability of a cut has increased since our last Capital Currents edition (from below 50% to above 75%) after the recent employment and CPI prints in the US and Canada.

Equities Market

The US equity markets have significantly outperformed Canadian markets, driven by a robust economy, improving corporate earnings, and a surging demand for AI-related stocks. Year-to-date (YTD) returns on the S&P/TSX Composite Index stand at 8.63%, while the S&P 500 and NASDAQ Composite Index boast returns of 18.40% and 24.60%, respectively. In the US markets, the technology sector (YTD: 36.92%) and communication services sector (YTD: 27.51%) have largely contributed to these gains.

The US tech-fueled rally has been propelled by booming AI demand. Mega stocks like Microsoft and Apple have seen gains of 24.19% and 22.34%, respectively, from January to date. Nvidia has been the standout performer, with a YTD return of 168.38%. The communication services sector has mirrored the robust performance of the technology sector, bolstered by impressive gains from key players including Google, Meta, and Netflix.

On the other hand, Canadian equities have faced greater pressure compared to their U.S. counterparts due to a sluggish economy and high interest rates. However, in the second half of the year, the situation is expected to reverse due to an anticipated economic slowdown in the U.S. and a delay in rate cuts by FED, which is now strongly expected in September.

Canadian markets have rebounded following the Bank of Canada's rate cut in its June policy meeting. This week, the S&P/TSX Composite Index reached a record high, marking its best performance since October 2023. The index closed at 22,673.52 recording a weekly gain of 2.79%, while returns of US Indices remained on a lower side this week.

On the S&P/TSX Composite Index, all sectors posted gains, with materials leading the way with an increase of 4.71%. Real estate followed closely with a gain of 4.66%, and consumer discretionary rose by 4.52%. In contrast, the technology and energy sectors were among the week's lower performers, recording gains of 0.87% and 1.41%, respectively.

The materials sector has been performing exceptionally well since the start of 2024, led by higher commodity prices for gold, copper and uranium. Increased prices for commodities like gold and other metals have bolstered the earnings and stock prices of companies within the sector. This was particularly driven by a spike in gold prices, as gold regained its status as a safe-haven asset amid geopolitical uncertainties and economic concerns.

Real Estate stocks have benefitted from the recent rate cut by BoC, which has improved market sentiment, lowering borrowing costs and making real estate investments more attractive. This move has encouraged investors to reallocate their portfolios towards real estate investment trusts (REITs) and property stocks, positively impacting the sector returns.

The consumer discretionary sector on TSX was largely benefited by the jump in Artizia Inc., which emerged as one of the top performers for the week following its impressive first-quarter earnings release. Aritzia's stock surged to its highest level since January 2023 posting a weekly gain of 21.77% as the company's Q1 fiscal 2025 financial results surpassed analyst expectations.

Fixed Income Market

The Canadian government yield curve has continued its bull steepening trend following the Bank of Canada’s (BoC) interest rate cut in June. The most significant movements have been observed at the shorter end of the curve, reflecting the market's anticipation of further rate cuts by the BoC. However hotter CPI data did reduce the rate cut expectation in July. Investors are keen to lock in higher yields as the market enters the early stages of a dovish cycle.

In particular, the 2-year to 10-year segment has experienced a yield decline, although this movement is less pronounced on the longer end of the curve. These shifts have been further amplified by a softer GDP projection for May and weak labor market data. The decline in yields has persisted since the GDP figures were released on June 26th. The labor market's soft numbers, with a loss of 1.4k jobs at the start of July, caused an additional dip in yields.

Moreover, weaker consumer sentiment, despite warmer temperatures, has failed to boost spending, reaffirming that high interest rates have induced the expected economic slowdown from restrictive policies. All data pointing towards an easing cycle make fixed income investments appealing, offering strong yields in an uncertain market outlook.

The CPI numbers from the USA and the congressional hearing of the Federal Reserve chairman have increased the probability of a rate cut in September to 84% in USA (Source). This development impacts rate cut expectations in Canada due to the reduced interest rate differential and the spillover effects from US. Consequently, yields across the Canadian curve fell, with the 2-year and 3-year falling the most by 5.9 basis points (bps) and 6.2 bps respectively, while the 10-year yield fell by 4.2 bps.

It is evident that the market is positioning for a bull steepening, with a focus on the shorter end of the curve. Examining rate cut expectations through the CAD Overnight Index Swap (OIS), the 1-month rate stands at 4.69%, the 2-month at 4.64%, and the 3-month at 4.59%.? This indicates that the market could see rates in the range of 4.5-4.75% in the following months

In summary, the current market dynamics, driven by softer economic data and rate cut expectations, position fixed income as a suitable investment, offering strong yields amidst an uncertain economic landscape.

Commodities

Crude Oil (WTI) had a volatile week ended with $82.8 per barrel. In Canada, the wildfire posts a threat to Energy producer and both Suncor and Cenovus Energy evacuated non-essential staff at their production cite while Suncor also curtailed production at its Firebag oil sands site. The Firebag oil site uses SAGD (Steam assisted gravity drainage) technology to lift oilsands from underground responsible for 215,000 bpd production. Northern Alberta wildfires force evacuations at Suncor, Cenovus sites | Calgary Herald.? Looking into the future, China also asked its state owned firms to purchase 60m barrel of oil for its reserves from July to March next year, which should be supportive for price.? SPR Mandate Offers Hope for Chinese Demand | Energy Intelligence.

Natural gas: had a tough week ended with $ 2.26 USD/MMBtu marking a two-month low due to larger than expected storage build according to EIA. Gas in storage is 18% above seasonal level and prices decreased due to increased output and the shutdown of Freeport LNG in Texas due to Hurricane Beryl which reduced LNG exports.? Fortunately, the situations is about to improve as Freeport is starting to restart its terminal? Weekly Natural Gas Storage Report - EIA

Gold reached $2410 USD/t.oz getting close to the May record high of 2426. Economic data indicated that headline inflation in the US slowed more than expected to 3% in June. Also, softening labor market strengthened expectation that the Fed will start cutting rate thereby lifting the price of gold. U.S. inflation broadly cools, bolstering case for Fed rate cut – BNN Bloomberg

Alternative Investments

Private Equity

Over the last two weeks, the private equity industry has seen a lot of activity. The $4.5 billion acquisition of financial technology company Envestnet by Bain Capital is one of the big highlights. Taking advantage of the increasing need for integrated financial services platforms, Bain Capital made this acquisition as part of its aim to strengthen its fintech capabilities.

IPO’s

Lately, the IPO market has performed inconsistently. Some businesses have successfully made their initial public offerings, while others have postponed them because of market volatility. The supermarket delivery service Instacart made a great launch despite early concerns about valuation, and its initial public offering (IPO) has drawn notice. This indicates a resilient but selective appetite for new listings in some industries.

Real Estate

The Canadian real estate market has stabilized during the last two weeks. Home sales have cooled off as a result of the Bank of Canada's recent decrease in interest rates, especially in large cities like Toronto and Vancouver. But the rental market is still competitive, with rents rising as a result of both a lack of available units and a rise in demand from recent arrivals. Market players will be keenly observing the Bank of Canada's upcoming interest rate decision, which is anticipated in July and might have a further impact on borrowing rates and real estate activity.

?Cryptocurrency

For the past two weeks, the bitcoin market has remained comparatively steady. The regulatory landscape is always changing. The European Union is making progress with its Markets in Crypto-Assets (MiCA) law, which seeks to give the sector more precise guidelines. Although there have been some little variations, Bitcoin and Ethereum are still trading within their current ranges. Numerous big banks are investigating blockchain applications for more effective cross-border transactions as institutional interest in blockchain technology and decentralized finance (DeFi) grows.

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