Lexicon Financial Group Weekly Update — May 15, 2024
“The supply-side effect of a restrictive monetary policy is likely to be perverse, in that high interest rates enter into costs and thus exert inflationary pressure.””
From the desk of Craig Swistun, CIM, MFA-P, Portfolio Manager, Raymond James Investment Counsel, and Wayne Hendry, Client Relationship Manager, Raymond James Investment Counsel
Looking Around
Look out! There’s a bear in the woods. The bear here being sticky inflation. Some say it’s hiding behind every tree, although it did cool off somewhat in April. According to the United States (U.S.) Labor Department, consumer prices rose 0.3 per cent from March to April, which is down slightly from 0.4 per cent in March. Measured year-over-year, inflation ticked down from 3.5 per cent to 3.4 per cent. This measure of underlying inflation, which excludes volatile food and energy costs, fell to its lowest level in three years.
We know a change of 0.1 per cent in a month isn’t usually something worth writing about, but it’s the direction of the trend that matters at this point. That’s because inflation has been unexpectedly high (sticky) in the first quarter of 2024 after having steadily dropped in the second half of 2023. This lowered the hopes that the worst period of inflation in four decades was being tamed quick enough.
On Tuesday this week, Federal Reserve Chair, Jerome Powell, reiterated that he expects inflation to ultimately reach the central bank’s two per cent target but that this was dampened after three straight months of elevated inflation. Inflation has fallen sharply from 9.1 per cent in the summer of 2022 but is now higher than in June 2023 when it was three per cent. So, if the U.S. is on track, it’s just a much longer track than was expected or predicted.
Economists are divided over whether the high inflation figures in recent months are merely echoes of pandemic-related price distortions. While auto insurance has soared 22 per cent from a year ago, for example, that surge may reflect factors specific to the auto industry. New car prices jumped during the pandemic, and insurance companies are now seeking to offset the higher repair and replacement costs by raising premiums. Stubbornly elevated apartment rents are another key factor behind persistent inflation. Rents soared during the pandemic as more Americans chose to live alone or sought more living space. These earlier increases are still elevating the government’s price data and may result in higher rates for longer in the U.S. (1)
In Canada, inflation rose in March mostly due to higher gas prices and higher shelter costs. According to Statistics Canada, the overall inflation rate was 2.9 per cent year-over-year in March, up from 2.8 per cent the previous month. Despite this rise, the broad-based easing in price pressures and improvement in all of Bank of Canada’s core inflation measures continue to point towards a potential interest rate cut coming this June or July. (2)
But the stubborn and higher-than-expected inflation in the first quarter did fuel speculation that rate cuts would come later this year or possibly into next year. This is based on a view that the Fed will see little merit cutting interest rates as long as inflation remains a bit elevated and employment is growing.
Some forecasters, however, argue the case that rate cuts are still on the table, given that the U.S. labour market is cooling along with softer wage growth. They contend that current measures of inflation are overstated because of lagging indicators, reflecting cost pressures from over a year ago, that will ebb in the coming months. They also believe that while the process of stabilizing prices, formally called disinflation, may face setbacks (especially any oil shock or widening of the two ongoing wars in Ukraine and the Middle East), it is still on track. Research teams at a couple of Wall Street’s most influential firms (Goldman Sachs and Morgan Stanley) remain steadfast in their belief in the gradual cooling of inflation and that a set of rate cuts are coming.
Only time will tell. As always, it’s useful to examine both sides of the debate. Because there are many who do not share this belief. The uncomfortable truth, according to these dissenters, is that the unusually low layoffs in the U.S. may have to end for wage growth and, ultimately, inflation to be fully tamed. The still-strong U.S. economy is leading to higher wage bills for employers who respond passing on this cost by raising prices when they can. In other words, there needs to be more unemployment. Just as a reminder, high unemployment generally translates to less people saving and less people spending money in the economy, which tends to keep indicators like inflation in check. That’s good for economics, but not good if you lose your job and are looking for employment.
Most economists picking apart the data agree that a continued willingness to pay for more expensive stuff (or “price insensitivity”) accounts in part for inflation’s persistence. As a result, expectations are that there will be little progress in coming inflation readings and that there will be no rate cuts from the Fed this year. (3)
That said, this is a U.S. election year and no President has wanted to go into an election when the economy is struggling or, worse, in a recession. Sometimes, governments like to pretend that they don’t influence the economy, but we need only look to the impact that massive COVID stimulus packages – flooding a country with cash – have had on inflation. Of course, it’s never “one thing” that causes inflation, or unemployment, or growth. The economy is complicated. Sometimes, the more you study it, the more complicated it gets and the more you learn, the less you know.
Looking Back
Canada’s economy added five times the number of jobs that were forecast for April and the unemployment rate unexpectedly held at 6.1 per cent. This news made market bets for a June rate cut look like a damp squib. Money markets now see a 44 per cent chance that the Bank of Canada (BoC) may cut interest rates next month – this is down from nearly 60 per cent previously.
The Toronto Stock Exchange’s S&P/TSX composite index (TSX) ended up last week despite some headwinds such as the TSX energy sector falling 1.2 per cent on the prospect of higher-for-longer U.S. borrowing costs, which could slow demand. The technology sector did not help either, as it fell two per cent, as shares of e-commerce company Shopify ended 5.6 per cent lower. (4)
Weekly North American Market Statistics
| Index | Week's Change | Year to Date |
| S&P 500 | 1.9% | 9.5% |
| Nasdaq Composite | 1.1% | 8.9% |
| Dow Jones Industrial Average | 2.2% | 4.8% |
| S&P/TSX Composite Index | 1.7% | 6.5% |
Source: Associated Press and FactSet 05/10/2024
Read and Watch
Want deeper insight into topics in your Weekly Update? Then, read and/or right click:
Video: What is inflation? Economics explained – The Guardian
Even 1.4 billion people can’t fill all of China’s vacant homes, ex-official admits
The S&P 500 Index neared its all-time high and recorded its third consecutive week of gains. Other major U.S. indexes also advanced, with value stocks generally outperforming growth stocks.
The surprise rise in weekly jobless claims seemed to dominate last week’s sparse economic calendar—at least in the eyes of investors. The number of people claiming unemployment benefits rose to 231,000 in the week ended the previous Wednesday, its highest since last August. Continuing jobless claims broke a four-week downward streak and rose to 1.79 million.
Last Friday brought another sign that the labour market and broader economy might be cooling. The University of Michigan reported that its preliminary index of consumer sentiment in May tumbled unexpectedly to 67.4 which is down from a final reading of 77.2 in April and marks its lowest level in six months. The yield on the benchmark 10-year U.S. Treasury note ended the week relatively unchanged after dipping to a nearly one-month intraday low on Tuesday.
In local currency terms, the pan-European STOXX Europe 600 Index ended 3.01 per cent higher on better-than-expected corporate earnings and increased optimism that major central banks would soon start cutting interest rates. Major stock indexes also rose sharply. Germany’s DAX gained 4.28 per cent, France’s CAC 40 Index put on 3.29 per cent, and Italy’s FTSE MIB added 3.06 per cent. The UK’s FTSE 100 Index climbed 2.68 per cent as the Bank of England (BoE) held its key interest rate steady at 5.25 per cent while indicating that it could ease policy as soon as June.
Japan’s Nikkei 225 Index and the broader TOPIX Index registered marginal weekly losses. This was within the context of Bank of Japan (BoJ) Governor Kazuo Ueda hinting that the central bank could raise interest rates early if upside risks to the price outlook emerge, given that inflation may have become more susceptible to the effects of weakness in the yen. The yield on the 10-year Japanese government bond finished the week broadly unchanged at around the 0.9 per cent level, which is near a six-month high.
Chinese stocks advanced as recovery hopes rose, following buoyant holiday spending during the prior week’s Labour Day holiday. The Shanghai Composite Index rose 1.6 per cent, while the blue chip CSI 300 gained 1.72 per cent. In Hong Kong, the benchmark Hang Seng Index added 2.64 per cent. (5)
The opinions expressed are those of Craig Swistun and not necessarily those of Raymond James Investment Counsel which is a subsidiary of Raymond James Ltd. Statistics and factual data and other information presented are from sources believed to be reliable, but their accuracy cannot be guaranteed. It is furnished on the basis and understanding that Raymond James is to be under no liability whatsoever in respect thereof. It is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of securities. Raymond James advisors are not tax advisors, and we recommend that clients seek independent advice from a professional advisor on tax-related matters.
U.S. inflation eased for the first time this year. How might the Fed react?, Christopher Rugaber, Global News, May 15, 2024
Inflation ticked higher in March. Are Bank of Canada rate cuts still in the cards?, Saba Aziz, Global News, April 16, 2024
What Forecasters Say About Interest Rates (and Why They Disagree),Talmon Joseph Smith, The New York Times, May 14, 2024
The close: S&P 500 higher but TSX slips as traders await key U.S. inflation data, The Globe and Mail, May 10, 2024
Global Markets Weekly Update, T. Rowe Price, May 10, 2024
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Looking to Learn?
If you want to know more about some of the topics we wrote about this week, just click on the links below:
Global inflation forecast: Will prices come down in 2024?