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Inflation Rises In Canada. How Could This Impact The Bank Of Canada’s Upcoming Decision On Rates? | Russell Investments

2024-11-22

BeiChen Lin, CFA, CPA

BeiChen Lin, CFA, CPA

Director, Head of Canadian Strategy




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hello everyone and welcome back to Market weekend review this is the episode for the week of November 22nd 2024 on today's episode there are three things that I would like to discuss the first is the most recent inflation data out of Canada and what the data means for the Bank of Canada the second is a look at some of the latest developments in the US earning season and finally I want to touch on a topic that doesn't necessarily get the most attention amongst investors but can nevertheless still be an interesting factor to consider so stay tuned and find out what that third topic is all right so let's start with Canadian inflation this week there were two important pieces of inflation data the first was the CPI and or the Consumer Price Index and the second was the PPI or the produc user price index so on the CPI what we saw was that on a lot of different measures Consumer Price pressures were a little bit hotter than expected whether it was the headline CPI coming in at 2% year-over-year or whether it was some of the bank of Canada's preferred measures of core inflation like CPI trim and CPI median also coming in a little bit hotter than consensus expectations ultimately when we look at the main measure of core inflation that the boc focuses on which is the average of CPI trim CPI median and CPI common what we see is that this average measure has accelerated to 2.4% year-over-year in the month of October as compared to 2.3% in the month of September and 2.2% in the month of August so although core inflation rates in Canada have come down from their peak in recent months it does appear that Consumer Price pressures have been a little bit on the sticky side and investors will be carefully monitoring whether those developments are more of a temporary setback or are something potentially a little bit more worrisome for the Bank of Canada now the second report on inflation we got this week was the PPI and the PPI for Canada also came in hotter than consensus expectations so when you combine the results of those two inflation reports for Canada what we saw was that market participants started reducing their expectations about the size of a December rate cut Market participants are now heavily leaning towards the idea that the Bank of Canada might only cut interest rates by 20 basis points in December instead of a supersized 50 basis point rate cut now from our perspective here at Russell Investments we're still keeping an open mind as to what the Bank of Canada might do in December the Bank of Canada will still get more data before they have to make their decision the Bank of Canada is going to have more GDP data it's also going to get a key jobs report at the beginning of December that will show what is the latest health of the labor market so all of those additional factors could still influence whether the Bank of Canada opts for 25 versus 50 so the second topic I want to talk about let's shift gears a little bit is now a look at the US earnings season and in general Q3 has been another robust quarter for us publicly traded companies it was good to see that headline S&P 500 earnings growth was around 10% year-over-year which is pretty healthy even when we exclude the impact of some of those Mega cap Tech names we still see earnings growth of around mid single digits which is once again still pretty resilient now although a lot of people this week were probably focused on the earnings report out of a particular large Mega cap tech company I was a little bit more focused on two consumer facing company earning reports instead and these two large US retailers had a bit of a contrasting development in their earnings report so one beat expectations and struck a positive tone in guidance One Missed expectations and was a little bit more downbeat in its guidance and ultimately what this goes to show is that the consumer sector even though consumer spending thus far has still been resilient it is still going to be an interesting watch point to see whether that resilience can still hold up in the fourth quarter and into 2025 now as a reminder our base case here at Russell Investments is that we think that the US economy can most likely avoid recession but in order for the US to be able to achieve that soft Landing we do need to see consumer growth and consumer spending still hold up so that's why I'm going to be very focused on the consumer sector into the Q4 reporting season which we'll get at the start of 2025 finally the last topic I want to discuss is a topic that doesn't necessarily get the most media coverage but nevertheless can still be an interesting development for investors and that is credit spreads credit spreads are basically a measure of how much incremental return investors could potentially get for investing in corporate bonds over government debt and what we're we're seeing is that that credit spread for us companies has compressed to amongst some of the narrowest levels in recent history for example the US credit spread for higho bonds has compressed to under 300 basis points now when we look at the health of us companies we do think that us corporates generally have robust balance sheets and so that could explain some of the compression and credit spreads and when we look at for example Market implied measures of recession risk the market generally believes that the chance of the US economy heading into recession in the near future is relatively low however from our perspective here at Russell Investments we still think that the probability of the US economy tipping into a recession is still somewhat higher than normal and so there could be a chance that these credit spreads might widen out in 2025 we're not yet at a point where we would say that investors should be thinking about tactically underweighting corporate credit because we don't yet see signs of an unsustainable extreme in the credit markets but nevertheless it is important we think for investors to stay disciplined and be aware of some of these developments in the corporate credit Market as well that's all for us stay tuned for the next edition of Market weekend review thanks everyone hi I'm Sophie Anto head of for portfolio and business Consulting at Russell Investments if you liked what you just saw and heard consider subscribing to our YouTube channel or check us out on LinkedIn thanks for tuning in

Executive summary:

  • Canadian inflation rates ticked up during October
  • U.S. Q3 earnings continue to look resilient 
  • U.S. credit spreads recently hit multi-year lows

On the latest edition of Market Week in Review, Investment Strategist BeiChen Lin reviewed the latest inflation numbers from Canada. He also provided an update on U.S. third-quarter earnings season and discussed the recent tightening in U.S. credit spreads.

October CPI, PPI numbers inch up in Canada

Starting with Canada, Lin said there were two major datapoints released the week of Nov. 18 pertaining to inflation—the consumer price index (CPI) and the producer price index (PPI). On the CPI side, both the core and headline readings came in hotter than expected, he remarked.

“The headline CPI increased to 2.0% in October on a year-over-year basis—slightly above consensus expectations for a 1.9% gain. In addition, two measures of core inflation—CPI-trim and CPI-median—also exceeded analysts’ expectations, rising 2.6% and 2.5%, respectively,” Lin stated.

All told, this pushed the average of the Bank of Canada’s (BoC) three preferred measures of core inflation to 2.4% year-over-year in October—up from 2.3% in September and 2.2% in August, he noted. Lin stressed that while inflation in Canada is still far below its 2022 peak, the numbers from the last few months have been a bit disappointing.

“Because of this, investors are carefully monitoring the situation to see if the recent uptick in inflation is a temporary setback—or a more worrisome trend for the BoC,” he remarked, adding that the October PPI numbers also came in stronger than anticipated.

As a result of both the CPI and PPI reports, Lin said market participants have reduced their expectations for the size of a December rate cut from the BoC. “Markets are now leaning heavily toward only a 25-basis-point (bps) cut instead of a 50-bps cut,” he remarked. However, Lin said the Russell Investments strategist team’s perspective is more open-minded, noting that the BoC will have a few more important data points to weigh—including third-quarter GDP (gross domestic product) and the October jobs report—before making a decision on rates.

U.S. Q3 earnings season update

Turning to U.S. third-quarter earnings season, Lin said that overall, corporate earnings continue to look resilient. S&P 500 headline earnings growth is around 10% so far, he said, although if the Magnificent Seven companies are excluded, that number drops to around 6%.

Lin noted that two large consumer companies reported the week of Nov. 18, with differing results—one with stronger earnings and forward guidance, and one with weaker earnings and forward guidance. The results from both were of significance, Lin said, because the consumer sector tends to be an important watchpoint for the health of the nation’s economy. “Simply put, consumer spending is a powerful driver of U.S. economic activity—contributing to roughly 70% of annual U.S. GDP,” he remarked.

Lin stressed that Russell Investments’ base-case scenario for 2025 remains a soft landing—where the U.S. economy slows but does not tip into a recession. However, in order for such an outcome to be achieved, consumer spending needs to remain resilient, he stated.

What’s behind the tightening in U.S. credit spreads?

Lin finished with a look at U.S. credit spreads, which he said are important because they measure the potential incremental return investors can get from investing in corporate debt over government bonds.

He noted that lately, spreads have compressed to some of the narrowest levels in recent history. As evidence, he pointed to the spread for U.S. high yield bonds, which has compressed to under 300 bps (basis points) over U.S. Treasurys.

So, why the tightening? Lin said it’s probably partly due to companies generally being in good financial health and partly due to the market pricing in a lower probability of corporations defaulting on their debt.

“From our perspective at Russell Investments, however, we’re a bit more cautious here. We think recession risks are still somewhat above average—and because of this, we think there’s a chance that these spreads could widen out a bit in 2025. However, we’re not seeing enough of an unsustainable extreme to want to tactically underweight credit just yet,” Lin remarked. He concluded by noting that during times of uncertainty like today, investors are probably better served by staying disciplined and continuing to monitor the latest data in the corporate credit market.

 

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