A not so nondramatic pause

Economic data

This week saw the Bank of Canada leave the overnight rate unchanged at 5.0%, in line with market expectations and in response to last week’s Q2 GDP report, which came in at -0.2% and well below expectations of +1.2% and the Bank’s +1.5% forecast. Still, the Bank’s written statement maintained a hawkish tone, noting further hikes could be warranted, as concerns with persistent underlying inflationary pressures remain. While the market’s reaction was uneventful, comments from government officials and analysts were more dramatic, with Finance Minister Freeland even issuing a statement calling the move a “welcome relief for Canadians.” While her comments were criticized by some as giving the impression of political interference with the Bank’s decisions, she did stress the importance of the Bank’s independence in maintaining monetary authority. Still, it’s a rare public affirmation with limited precedence for Canada’s Finance Minister to make. Looking at the Bank’s statement, some analysts argued that comments were overly hawkish, with some noting that had you skipped the part about keeping rates unchanged, you could have thought they had again hiked rates. However, some see this as the end of the hiking cycle, with Governor Macklem even noting in a speech later in the week that the 2% inflation target is “now in sight”. Ultimately, future policy movements will be data dependent, with further easing in inflation necessary to justify any rate cuts. We’d argue that the Bank has made significant progress to cool inflation pressures that fall within their control. For argument’s sake, revisiting consumer price index (CPI) data for July, we saw the core-CPI median come in at +3.7% year over year. However, excluding mortgage costs, which are up more than 30% year over year, core CPI came in at 2.3% year over year, and on a 3-month annualized basis came in at 1.7% year over year.?

Other economic data this week in Canada included international merchandise trade which, although it still came in at a $1 billion deficit, exceeded expectations partially due to lower imports attributed to the ports strike in British Columbia and the flooding in Nova Scotia. Employment data for August exceeded expectations, adding 39,900?jobs in the month, but the bulk of these gains were self employed, while actual employees fell by almost 10,000. However, hourly wages of private employees rose by 5.2% year over year, up from +5.0% year over year in July, which is counter to what the Bank of Canada wants to see to meet its objectives. In the US, economic data was more resilient with the ISM Services PMI Index coming in at 54.5 in August, exceeding expectations and above the previous month’s 52.7. Both the new orders and employment sub-indices also improved, signaling ongoing economic resilience driven by consumer spending. Factory orders also came in stronger than expected, and excluding transportation increased by 0.8% on the month. Lastly, non-farm productivity for Q2 was revised modestly lower from +3.7% to +3.5%, coupled with lower output, which caused unit labour costs to move higher, from 1.6% to 2.2%. Still, this reflects an improvement from the 3.3% seen in Q1 and 6.6% in Q2 of last year. Historically, unit labour costs have been a strong gage for medium term inflation expectations, which we would argue at 2.2% is consistent with the Fed’s 2% inflation target.?

Bond market reaction

Bond yields were higher on the week, partially attributed to stronger than expected US economic data, but also due to a significant amount of new corporate supply both in Canada and the US, causing both dealers and investors to sell government bonds and make room for new corporate issues. In Canada, corporate issuance was dominated by supply in the telecommunications sector, with both Telus and Rogers coming to market with large multitranche issues. Investment grade credit spreads were modestly weaker on the week, as the market looked to digest new supply. However, credit remains strong with new issues being well oversubscribed and transactions only needing modest concessions. Other activity also included announcements of merger and acquisition activity from both Enbridge and Intact, which modestly impacted spreads negatively, due to increased bond supply expectations. Still, both transactions were perceived favourably from an operational perspective, being accretive and enhancing operations.?

Stock market reaction

Global equity markets were volatile this week, especially following the announcement from China banning the use of iPhones in some government agencies. The announcement comes days before Apple plans to unveil its latest suite of products. It remains to be seen how Chinese consumers react, as the region is the company’s largest international market. In Canada, several large acquisitions took the spotlight. Enbridge announced a C$19 billion takeover of three natural gas utilities from Dominion Energy. The deal comes at a reasonable price and upon close will see Enbridge become North America’s largest natural gas utility company serving 7 million customers. Intact Financial, also announced their intention to acquire Direct Line’s brokered commercial lines operation, and Peyto Exploration & Development announced the acquisition of Repsol’s exploration and production assets for just under $500 million.?

What to watch next week

Next week in the US we get the National Federation of Independent Business’ (NFIB) small business optimism survey, CPI, producer price index (PPI), retail sales, business inventories, Empire State Manufacturing Index, industrial production, and capacity utilization. In Canada we’ll see wholesale and manufacturing sales, international securities transactions, and existing home sales.

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

Adam Ditkofsky is Senior Portfolio Manager, Global Fixed Income; Pablo Martinez is Portfolio Manager, Global Fixed Income; Sandor Polgar, Portfolio Manager, Global Fixed Income; Steven Lampert is Associate Portfolio Manager, Global Fixed Income; Craig Jerusalim is Executive Director and Portfolio Manager, Equities; and Rahul Bhambhani is Portfolio Manager, Global Equities.

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