Spooky forecasts

Economic data

The Fall season is very much here with pumpkin spice lattes and Halloween decorations overflowing at every street corner. The Bank of Canada (BoC) is getting in the spooky spirit, as Governor Macklem did his best to tame market expectations that we’re at the end of the Bank’s rate hiking cycle. Though the BoC maintained its policy rate at 5.00% earlier this week, the Governing Council warned that core inflationary risks are re-emerging and that it’s prepared to raise rates further if needed. That message wasn’t exactly surprising to investors, as central bankers around the world continue to talk tough on inflation. Particularly in Canada, that message comes despite some evidence of progress in recent consumer price index (CPI) reports as well as softer employment data. However, the Bank is still forecasting above-target inflation as shown in its updated Monetary Policy Report?(MPR) – 3.3% this year and 2.5% in 2024, both a few ticks higher than the previous forecast, and then returning to the 2% target by the end of 2025. Don’t fret though– it could be worse given the Fed’s most recent projection showed US CPI returning to its target a whole year later in 2026. But the real spooky part of the MPR comes when you couple the above-target inflation projection with its updated growth forecasts. The Bank now sees GDP rising at a modest +1.2% pace this year before decelerating to +0.9% in 2024. Those projections are downgrades from the Bank’s prior forecast, largely owing to weaker consumption and housing contributions, both clear consequences of higher rates. The broader point is that by taking together the BoC’s new inflation and growth forecasts, the report has undertones of a boogeyman no one wants to face – one named stagflation! While it’s too early to declare that we’re in that reality, the Bank is on notice and hopes that moderating growth will ultimately drive core inflation towards their target.?

The US, at least to this point, doesn’t have a growth problem. The advance read of Q3 GDP came in above expectations at +4.9% on stronger personal consumption. That’s been the key factor in avoiding the well-anticipated recession, and it reiterates that in aggregate, American consumers are simply less sensitive than Canadians to higher interest rates. The difference in our mortgage markets is certainly one major reason. The question now for investors is whether that rate of economic growth is sustainable. Odds are it’s not. Firstly, inventories boosted the Q3 number by over +1%, which should partly reverse in coming quarters. Consumer spending is also more likely to plateau than keep rising at its current torrid pace. Finally, non-residential investment was a particular weak point in the Q3 number, falling by -0.1% and showing softness in business activity. Recall, this includes spending on more interest-sensitive categories like equipment, which should continue to moderate.?

Bond market reaction

The recent volatility in bond yields continued this week, with the US benchmark 10-year reaching 4.95% on Wednesday before rallying lower towards the end of the week. An overarching theme has been the renewed steepening of the yield curve, signaling a more resilient economic outlook coupled with growing concerns about rising government deficits. In Canada specifically, a lack of long-end supply is also supporting demand for both corporate and government bonds, making Canada’s sovereign long bonds look like some of most expensive in the developed world. The corporate bond new issue market has been quiet with Q3 earnings in full swing, a reprieve for investors following a busy September calendar. High yield spreads defied the equity market weakness and were only modestly wider on the week.?

Stock market reaction

Equity markets have been more volatile to start this earnings season, with investors punishing companies reporting poor earnings updates. Asian markets have outperformed on a relative basis. In the US, TransUnion reported Q3 results by taking down full-year guidance and giving commentary to investors on a slowing lending market. While a slowdown in mortgages has been well articulated since the peak in 2020 and 2021, we’re starting to see weakening trends in subprime lending across most categories. Data is a high-margin business, so the company will also see their profits fall disproportionately. It’s no secret that lower income earners have battled with inflation over the past two years, and lending is finally seeing a slowdown. TransUnion’s stock is down over 30% this week on the announcement. Across the pond, French-based payments company Worldline faced a similar fate for different reasons. Worldline cited a sharp slowdown in select European countries due to weak consumer spending alongside a decision to curb relationships with high-risk merchants. The company is also expecting free cash flow to worsen amidst a slowing environment. Publicly-listed companies in the fintech sector have been subject to casualties given rising competition and macro sensitivity. It’s certainly turning out to be an interesting start to earnings season.?

What to watch next week

It’s a busy week of primary data in Canada with August GDP and updated employment figures for October. Attention turns to the US on Wednesday for the Fed’s rate decision, followed by the important non-farm payroll report on Friday.

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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