United States Highlights
- Market sentiment deteriorated this week on stronger than expected CPI data and a weak start to the corporate earnings season.
- The US CPI accelerated in June, rising 1.3% m/m, pushing the measure from a year ago to a new multi-decade high of 9.1%. Core inflation accelerated by 0.7% m/m, with strong gains seen in the goods (0.8% m/m) and services (0.7% m/m) categories ).
- June retail sales surprised on the upside, with the stock (1% m/m) and control measure (0.8% m/m) posting decent nominal gains. However, sales were lower after adjusting for inflation.
- The Bank of Canada announced a surprise rate hike of 1% this week as fears of high inflation persist.
- Existing home sales and home prices continue to decline as rising rates put pressure on markets.
- Next week, all eyes will be on the Canadian CPI release, which is expected to show another surge in inflation.
USA – Gotta bend before you can break
Market sentiment shifted decisively into risk aversion mode this week as a stronger-than-expected CPI print and a weak start to the corporate earnings season helped cast further doubt on the economic outlook. As of this writing, the S&P 500 is down 2% on the week and has now had one of the worst starts to a year in nearly a century. Deteriorating market sentiment has led to a further widening of the yield curve inversion, underscoring growing fear among market participants that a recession is looming. The 10Y-2Y spread is now at -20 basis points (bps). Poor market sentiment also spread to commodity markets, with WTI falling 8% to $98 a barrel on the week.
Any hopes of easing inflationary pressures in June were quickly dashed on Wednesday after the Bureau of Labor Statistics released last month’s CPI data. Headline CPI accelerated 1.3% month-over-month (m/m), pushing the prior-year measure to a new multi-decade high of 9.1%. Indeed, with fuel prices jumping 11% last month and more recent gains in food prices showing incredible persistence, further acceleration in the overall measure was inevitable. What was not anticipated, however, was the rise in underlying inflation (0.7% m/m). What is perhaps most disconcerting is the magnitude of the price increases across commodities, particularly among commodity categories (Chart 1). Further increases in goods prices are at odds with more recent spending data, which showed consumers have reduced their purchases of most discretionary goods in recent months. While inflation is notoriously a lagging indicator, it was thought that the combination of weakening demand and anecdotal reports of retailers carrying excess inventory would soon begin to put downward pressure on commodity prices. That narrative has yet to come to fruition, and that detail will not be lost on policymakers when they meet later this month.
Perhaps some encouraging news came from the July reading of the University of Michigan consumer confidence survey, which showed that inflation expectations over the next five years are now at 2.8%, down from last month’s reading of 3.1% (Chart 2). Chairman Powell pointed to the recent upward drift in inflation expectations as a major contributor to the FOMC’s decision to raise rates more forcefully in June. While the decline will bring some relief to policymakers, it will not be enough to deter them from moving forward with another oversized hike later this month. This sentiment was reflected in market prices, with almost random odds on whether the Fed will hike 75 basis points or 100 basis points.
The big question now is to what extent rising interest rates will ultimately weigh on domestic demand. Retail sales data for June showed consumers remain somewhat resilient, with both the stock (1.0% m/m) and control (0.8% m/m) up on the market. month. That said, consumer spending is only tracking around 1% q/q (annualized) for the second quarter, which is a marked slowdown from the 4.5% average in the second half of last year. . As inflation continues to erode purchasing power and rates are set to rise decisively through the end of the year, the hope is that consumers will only bend under the brunt of the shock of the double income and will not break completely.
Canada – BoC offers shock 1% hike
The Bank of Canada (BoC) made global headlines this week with a super 1% rate hike (Chart 1). While we’ve run out of superlatives to describe the magnitude of the Bank of Canada’s actions, we expect more action to come as inflation is poised to continue to hover at elevated levels. Financial market participants expect further rate hikes of 1% to 1.25% over the course of this year.
The BoC reduces growth and raises inflation
In the Bank of Canada’s Monetary Policy Statement, there were a number of nuggets revealing insight into the Bank’s thinking. The first is the change in their growth forecast. The Bank said economic growth will slow from 3.5% this year to 1.75% in 2023 as global economic momentum slows due to higher global interest rates and high inflation.
As for inflation, the BoC’s new forecast shows that it believes the CPI will remain around 8% over the next few months and slow to just 7.5% by the end of this year. to reach 3.2% by the end of 2023. This means that the central bank will not be able to bring inflation back to the target range (1%-3%) within its window. monetary policy for 12 to 18 months. Given the recent Business Outlook Survey and the Canadian Consumer Expectations Survey, which showed an easing in inflation expectations over the forecast horizon, the Bank of Canada’s forecast of a higher inflation for longer is relevant.
We also got data on existing home sales in Canada and home prices on Friday. Following the recent trend, sales were down another 5.6% month-over-month (m/m). Combined with the 4.1% m/m increase in new listings, the sales-to-listings ratio continued to decline towards equilibrium (51.7%). This led to a further 4.3% m/m decline in the average Canadian home price, pushing the peak-to-trough decline to a whopping -14% since February.
Looking forward to next week
All eyes will be on Wednesday’s CPI release next week. With inflation already at 7.7% YoY, expectations are for a reading of +8% on the headline figure (chart 2). We expect further increases in food and fuel price pressures, which have been the main drivers of inflation in recent months. Any upside inflation surprises will likely cause markets to further price the Bank of Canada hikes. The recent price revision caused the Canada 2yr to continue to rise, while the Canada 10yr remained flat just above 3%. This pushed the 10-year/2-year yield spread (a popular recession signal) even deeper into negative territory. Although the BoC is still anticipating a soft landing, where it raises rates without triggering a recession, markets are bracing for a bumpy ride.