Vibecession

There is a general feeling of discontent out there. Consumer confidence and business optimism surveys show a degradation in sentiment in the past few months—even though gross domestic product (GDP) growth remains strong and equity markets are close to record highs. This disconnect between actual and perceived economic performance has been coined Vibecession, a neologism combining the contraction of the words vibes and recession.

One reason which might explain this gloominess could be the impact that higher asset prices and interest rates are having on different demographic groups. Boomers are loving every minute of it as their retirement funds are propelled higher. Most Gen X-ers were lucky enough to sweep up real estate before the boom and lock in low pre-pandemic mortgage rates for the next few decades (in the US). The younger cohort though is not so lucky. Inflated asset prices and high interest rates result in millennials being priced out of the housing market. This is why central banks have been working so hard at making sure price levels drop to the 2% target level.

Economic data

Economic data from this week suggests efforts from central banks are starting to bear fruit. The US April Consumer Price Index (CPI) came in lower than expectations at 0.3% and the yearly number also edged down to 3.4%. The rate of core inflation saw its first decline in six months at 0.3%. The details of the report also showed encouraging signs as services finally moderated. While shelter inflation remained steady at 0.4%, services excluding rent decreased materially from 0.8% to 0.2%, a sign that the labour market is rebalancing. Another positive point on the wage front is the deceleration in real average hourly earnings to 0.5%, continuing the downwards trend we’ve seen so far this year. Those numbers remain too high for the US Federal Reserve (Fed) to consider a rate cut in the near term, but the numbers show that the current policy stance is tight enough to slowly get inflation back to target.

Higher rates remove discretionary purchasing power from consumers, which may explain the flat retail sales number for the month of April —far from the 0.5% increase that was expected. Although the miss was quite big, the number comes after two months of large increases in sales. So, it should be interpreted as a normal rebalancing that will put the quarterly number at a level strong enough to maintain GDP growth without pushing inflation higher. Another sector affected by borrowing cost is construction. New home sales came out almost a full 2% lower than expectations of 5.7%. Building permits continued their fall with a -3% print after a 5% decline in March.

Bond market reaction: Reacted favourably

The bond market reacted favourably to the CPI number as it was conditioned to see higher than expected prints in the past months. Better inflation, coupled with cooling retail sales took the US 10-year bond yield lower by 10 basis points (bps) to 4.40%. Curves on both sides of the border steepened as investors gained confidence that the central banks will be able to deliver the much anticipated rate cuts. Corporate spreads remained stable as equities performed well and the new issue market stayed relatively calm.

Stock market reaction: Only a tad weaker

While equity markets are a tad weaker heading into the weekend, US equites once again flirted with all-time record highs. The Dow Jones Industrial Average topped 40,000 and the S&P500 topped 5300 for the first time ever. Moderating inflation and the prospects of lower interest rates boosted rate-sensitive sectors such as Healthcare, Utilities and Communication Services as well as high-growth, long-duration sectors like Technology.

In Canada however, Technology was dragged down slightly by Shopify’s hangover from last week’s guidance outlook. That being said, the Canadian technology bellwether is now trading close to its trough valuation, (well below many of its US peers) despite continued leverage to e-commerce and service. This valuation discrepancy with US peers is apparent across most sectors as well as for the overall benchmarks. The S&P500 price-to-earnings multiple is now more than one standard deviation above its long-term average. The S&P/TSX remains below its own average and at a record discount to the S&P500. Part of the explanation has to do with relative earnings growth. However, much of the gap should narrow with moderating interest rates and converging growth outlooks. Next week will see the start of bank reporting beginning with TD Bank on Thursday. The embattled bank will hopefully update the market on some of the Anti-Money-Laundering allegations impacting their performance. We should start to get an informative reading on overall Canadian lending and credit trends as well.

What to watch in markets next week

After a slow data week in Canada, things will pick up next week with the last CPI and retail sales numbers before the next Bank of Canada (BoC) rate decision on June 5, 2024. Those two numbers will be critical in assessing if the BoC will begin to lower rates at that meeting. In the US, we’ll get new and existing home sales numbers as well as the Federal Open Market Committee (FOMC) minutes from its last meeting.

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

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