Nothing easy

Economic data

It’s not enviable being a central banker these days, and the Bank of Canada’s job was made tougher this week in the face of a hot July inflation report. The headline Consumer Price Index (CPI) advanced +0.6% month over month, exceeding even the highest estimate among surveyed economists and bringing the annual rate to +3.3%. That marks a reversal from the prior downtrend and an acceleration from June’s sub-3% print (+2.8%). Part of the acceleration is technical, given last year’s large decline in gasoline prices fell out of the annual calculation this month – thanks, “base effects”. But we can’t ignore that rising food costs, electricity bills, and shelter prices all contributed to a higher headline number. The shelter category is of particular concern for Canadians with the current supply-demand imbalance in the housing market. In fact, mortgage costs received a special shoutout in Statistics Canada’s official release since they rose a record +30% year over year in July! Ironic because those mortgage costs move directly with the Bank’s policy rate, perversely implying that rate hikes can also be inflationary. Couple those points with the fact that August headline CPI is expected to accelerate again due to the same “base effects” and the recent jump in gas prices, and suddenly the Bank appears to be in another bind. 

It's not all dire though. Removing the more volatile categories, core inflation is elevated but critically not accelerating. The ex-food and energy CPI sits at +3.4% year over year, a tick below the prior month, while the average of the new core trim- and median-CPI calculations slightly receded to 3.65%. Moreover, excluding just the mortgage interest costs mentioned above, headline CPI would’ve advanced +2.4% year over year, which is more aligned with the Bank’s 2% target. Looking ahead, there’s little standing between this inflation report and the Bank’s next rate decision in September, but the upcoming June GDP release will be key – recall the flash estimate of a -0.2% month over month decline would leave Q2 tracking at 1% annualized and, importantly, half a percentage point below the Bank’s own Q2 growth forecast. If that flash estimate holds, the Bank’s decision will be even tougher. 

South of the border, the old adage of “never underestimate the U.S. consumer” was in full force this week. July retail sales popped at +0.7% month over month, with the core control group even higher at +1.0%. Both those numbers blew past expectations, as online sales were buoyed by Amazon Prime Day. The print may be confounding for the Fed, though one silver lining is that more interest-sensitive categories like furniture and building materials continue to retreat on an annual basis. Unfortunately, the Federal Open Market Committee (FOMC) July decision minutes released this week didn’t make the Fed’s current thinking any clearer to investors. Fed participants reiterated their data dependence position while acknowledging the need to balance the risk of overtightening. The Leading Economic Index (LEI) is certainly arguing for a slowdown as it fell -0.4% month over month in July, marking its 16th straight decline. Consecutive monthly declines of that length in the LEI have always preceded a recession. 

Bond market reaction

Canadian and US bond markets sold off as yields approached new cyclical highs across a number of benchmark tenors. The 10-year Treasury cleared 4.30% on Thursday, a level last seen in 2007, while the 10-year Canada bond briefly touched 3.80% which would also mark a post-2007 high. A key theme has been the renewed steepening of the yield curve with longer-term yields rising on the resilient economic data and warnings over rising government deficits. Early Friday morning this appeared to reverse, consistent with broader global growth concerns emanating from China. There, weak data coupled with disruptions in the property and shadow banking sectors prompted their central bank to surprisingly cut one of its main lending rates. Corporate bond spreads mostly shrugged off the volatility and ended the week modestly wider. 

Stock market reaction

US equity markets sold off this week as investors once again focused on the possibility that interest rates could continue their march higher. In the meantime, data out of China continues to be weak, posing a challenge for some Asian and European equities. An interesting breakthrough worth pointing out is Contemporary Amperex Technology Co., Limited’s (CATL) announcement on fast-charging electric vehicle batteries, which can achieve a 400 km range in 10 minutes of charging. In contrast, traditional batteries take several hours whereas fast-chargers today can take up to an hour. CATL is already a dominant force in global batteries, and continued innovation like this week’s announcement should allow them to stay a leader. It remains to be seen where prices land and how quickly auto manufacturers adopt the technology. On a more somber note, recent fires in Maui, Hawaii, may have been caused by downed power lines, or so lawyers posing lawsuits against Hawaiian Electric have suggested. Early estimates suggest the cost to rebuild will be in the $5-6 billion range, and the company may be liable for a portion of that if causation can be found. Investors ran for the exit upon emergence of this news given similar hiccups in Californian utilities companies previously. 

What to watch next week

Data is light in Canada apart from the retail sales report for June. The US sees updated data for existing and new home sales, durable goods orders, and the University of Michigan sentiment index. We’ll also be watching for any telling comments out the Fed’s annual confab at Jackson Hole later in the week.

By: 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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