Summertime, and the living is…not so easy

Economic data

Consumers are definitely feeling the pain from higher prices during this year’s summer vacation. Let it be at gas stations, restaurants or grocery stores, enjoying some time off means digging deeper into our pockets. For the first time in many decades, people realize the damage inflation can cause to the economy and particularly to those at the lower end of the earnings spectrum, who need to spend and increasing share of their income on necessities. Politicians would be wise to take notes as some of their predecessors lost their job partly due to uncontrolled inflation. President Biden should brush up on Richard Nixon’s biography and Prime Minister Trudeau just has to go through some family albums to see that higher prices means angry voters.

Fortunately, the consumer price index in Canada showed a glimmer of hope as the monthly number came out lower than expected at 0.1% for June while 0.3% was expected. That takes the year-over-year change to 2.8%, closer to the central bank’s target. The other side of the coin here is that a lot of the drop can be explained by the base effect, as very high consumer price index prints from last year are being removed from the calculation. More important for central banks, core measures, which remove the most volatile elements from the number, remain sticky close to the 4% mark. Nevertheless, higher rates seem to be putting a dent on spending in Canada as May retail sales came out at a disappointing 0.2%, lower than the flash estimate and expected number of 0.5%. Volumes were relatively flat, rising by only 0.1% and the flash estimate for June is not encouraging with a flat reading. It is never good news to see consumers paring back on their spending, but this is in line with the bank of Canada’s plan to cool off the economy.

In the US the old adage of never underestimating the U.S. consumer held true as retail sales were more encouraging. Yes, the overall number came out lower than expected at 0.2% vs 0.5%, but the prior month was revised up and the control group, which feeds more directly into GDP calculations came out at 0.6%. Real consumer spending was also up 0.3%. Initial jobless claims came out and the number was closely watched as this week’s result will be used for calculating the next nonfarm payroll number. Once again, claims remain low at 228,000, indicating a healthy job market. Remember that employment is a lagging economic indicator; we got a glimpse of what to expect in the next few months as the leading index for June came out at -0.7%, lower than expected and the 15th consecutive negative print, pointing to a decelerating economy.

Bond market reaction

Although we saw high volatility during the week, yields were close to unchanged with the 10-year Canada bond closing at 3.40%, well within the last month’s trading range. The yield curve initially steepened on the prospect that central banks were near the end of their tightening cycle, but good economic data in the U.S. reversed the move later in the week. Corporate bonds improved slightly as the good performance from the stock market, coupled with low issuance from borrowers kept spreads well bid. These quiet times unfortunately do not last; expect the action to resume once people are back from holidays.

Stock market reaction

Isolated fireworks in global equity markets this week with earnings season underway. Starting with the U.S., one trend worth pointing out is the increasing comfort seniors have demonstrated in returning to hospitals for elective procedures. Covid-19 fears had resulted in multi-year pressure on procedures, but recent commentary from managed care companies in addition to Q2 results at medical device manufacturers suggests normalization is underway. In fact, staffing shortages at hospitals are causing bottlenecks given backlogs. Cardio procedures are up double-digits in many cases, with the strength expected to continue for the remainder of the year. Somewhat related, we continue to see covid-19 related testing fall off a cliff as testing frequency falls. In the world of technology, Netflix provided insight into password sharing crackdowns, a recent venture management decided to embark upon. The results hinted at slowing revenue per user but churn of consumers is largely under control. Some question marks over advertising revenues still remain. It should be an interesting year to follow developments at Netflix especially as free cash flow inflects higher.

What to watch next week

We should be expecting some excitement next week as the Federal Reserve will announce its rate decision. Although the market is expecting another increase, the following statement and press conference from Jay Powell will be scrutinized as usual. We will also be getting the U.S. GDP advanced number for Q2, as well as personal income, spending and the personal consumption expenditure deflator. The calendar is lighter in Canada, with the release of the May GDP and results from the Survey of Employment, Payrolls and Hours (SEPH).

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 Senior Research Analyst, Investment Research; Craig Jerusalim is Executive Director and Portfolio Manager, Equities; and Rahul Bhambhani is Portfolio Manager, Global Equities.

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