Global financial markets rallied in April, despite a slowdown in the global economy during the first quarter of the year, which fell short of economists’ forecasts. However, the earnings season has been a bright spot as a greater-than-usual percentage of S&P 500 companies exceeded analysts’ expectations. As central banks worldwide prepare for their meetings, inflationary pressures continued to ease, leading to declining government bond yields in major economies. Additionally, the price of US crude oil fell to below $75, a decrease from its $83 peak in April. Looking ahead, the US Federal Reserve is expected to announce a quarter-percentage-point increase in its key benchmark interest rate, reflecting the central bank’s confidence in the strength of the US economy.
Canada
The S&P/TSX Total Return Index was up 2.9 percent in April after Canadian economic growth slowed; inflation remains a concern as the Bank of Canada maintains a rate of 4.5%.
The Canadian economy grew less than expected in February, increasing by only 0.1 percent from the previous month, which was lower than the 0.2 percent forecast by analysts. Additionally, according to a preliminary estimate, it is likely to shrink in March by 0.1 percent. The economy likely grew 2.5 percent on an annualized basis in the first quarter, exceeding the Bank of Canada’s forecast of a 2.3 percent rise in real GDP. However, the ongoing strike by federal government workers, which is now on its 10th day, will likely affect this month’s growth and weaken the start of the second quarter. The strike is impacting services such as tax returns and passport renewals. Some economists stated that the Canadian economy appears to have stumbled in the early spring after a solid start to the year.
Canada’s economy added 34,700 jobs, mostly in the private sector, in March, keeping the unemployment rate steady at 5.0%. This exceeded expectations, as analysts had forecasted a net gain of only 12,000 jobs and an increase in the unemployment rate to 5.1%. This marks the seventh consecutive month of job gains and brings the total increase in employment since September to 383,000. Despite the aggressive rate hiking cycle, the labor market has been resilient, with the unemployment rate remaining near its all-time low. However, wage growth was slightly lower than expected, although it remains at multi-decade highs. While the Bank of Canada notes that labor market tightness has been easing, wage growth remains elevated and puts upward pressure on inflation.
Canada’s annual inflation rate decreased in March to 4.3%, the slowest pace in 19 months, primarily due to declining energy prices that offset the surge in mortgage costs. However, the rate still exceeds the Bank of Canada’s 2% target. The bank had projected that the headline inflation would cool to about 3% by mid-2023. Still, the continued strong demand and the tight labor market are putting upward pressure on many services prices, which may keep the headline figure from hitting 2% until the end of 2024. The March inflation reading benefited from a comparison to last year’s substantial price increase. While the inflation rate is coming down, it remains a concern for Canadian central bankers.
On monetary policy, The Bank of Canada (BoC) has maintained its policy rate at 4.5% in its latest announcement, following eight consecutive rate hikes in the past year. This decision was widely anticipated, as the BoC had previously indicated its intention to pause. Despite concerns over inflation, the bond markets reacted positively to the announcement. However, the BoC has acknowledged that returning to its 2% inflation target will be challenging. There have been discussions about potentially keeping rates elevated for extended periods. The BoC expects to see a return to 3% inflation by mid-2023.
US
The S&P 500 Total Return index was up 1.6 percent in April as the US economy and politics face challenges with the debt ceiling, slow growth, strong jobs, slight inflation drop, and Fed divergence.
The US House of Representatives, controlled by Republicans, has passed a bill to raise the debt ceiling, which is unlikely to become law as it includes eliminating several Biden administration priority programs and cuts to tax enforcement funding. This highlights the deep divide between the two parties. The administration has expressed willingness to negotiate fiscal policy only with a standalone debt ceiling increase, which the House Speaker has rejected. If the US does not increase its borrowing limit, it could eventually default on its debt obligations. The deadline for action could be as soon as early June, and concerns about the debt ceiling have caused disruptions in the Treasury bill market. If the US can stretch its cash until mid-June, the X-date should shift toward late July or early August.
The US economy expanded at a slower pace of 1.1% in the first quarter of this year, falling short of economists’ expectations of 2.6%. This deceleration was due to businesses rebalancing their inventories and reducing spending in response to the Federal Reserve’s rate hikes. The slowdown comes amid mounting concerns over the banking sector’s instability and the impending debt ceiling crisis, which could potentially trigger a recession. The GDP report confirms that the US economy has lost momentum recently, with many economists projecting an impending recession. Despite the Federal Reserve’s nine consecutive rate hikes to cool the economy, it remains robust. However, Economists predict that the economy may grow by 0.8% in the second quarter and then enter a mild recession in the third quarter due to the impact of tighter monetary policy.
The US economy added 236,000 jobs in March, pushing the unemployment rate to 3.5%, as the strong job growth suggests persistent tightness in the labor market. The report also revealed a 0.3% increase in average hourly earnings in March, causing the annual wage increase to drop to 4.2% from February’s 4.6%. However, the wage increase is still higher than the Fed’s 2% inflation target, and officials will await inflation data to determine the impact of their monetary policy tightening campaign. Despite the recent failure of two regional banks in March, financial market stress did not appear in the employment report.
US inflation decelerated in March to its lowest level in almost two years, as the consumer price index (CPI) increased 5% YoY, a decrease from February’s 6% rise. Despite the drop, underlying inflationary pressures persist, especially shelter costs, which have significantly contributed to core inflation. Core prices, which exclude the volatile energy and food sectors, rose 5.6% YoY in March, up slightly from 5.5% the previous month. While some costs, such as groceries, gasoline, medical care, and utilities, decreased, others, including shelter, airline fares, and vehicle insurance, increased.
On monetary policy, economists predict that the Federal Reserve will increase interest rates by 25 basis points at their meeting, which is widely expected and reflected in interest rate futures pricing. However, this is likely the last rate hike in this cycle. After the meeting, there is a divergence between the Fed’s messaging and market expectations on the possible policy outcomes. The Fed is focused on elevated inflation expectations and low unemployment rates while forecasting a 5.25% overnight rate through the end of the year. In contrast, interest rate futures investors are predicting two rate cuts this year. The slowing economic activity and rising growth headwinds from fiscal policy and the banking sector may justify rate cuts this year, but there is a risk that the Fed may keep rates too high for too long.
International
The MSCI ACWI Ex-US Total Return Index was up 1.8 percent in April after China saw deflation, Eurozone growth missed’ expectations, and the UK economy stagnated due to inflation and strikes.
While many countries are struggling with high inflation, China is facing deflation, despite the People’s Bank of China’s efforts to boost the economy by cutting interest rates and injecting cash into the financial system. Consumer prices rose by 0.7% in March, while factory gate prices fell for the sixth month. The country’s GDP grew by 4.5% in the first quarter, mainly reflecting pent-up demand from shoppers following three years of pandemic restrictions. The unusual combination of price declines and unprecedented money supply in the economy has fueled talk of deflation, which could cause consumers and companies to put off spending in anticipation of prices falling further, exacerbating economic problems.
The eurozone economy grew less than expected in the first quarter of 2023, with preliminary data showing that GDP increased by 0.1%. While this was an improvement from the flat growth recorded in the final quarter of 2022, it fell short of the 0.15% growth predicted by economists. Germany’s economy remained stagnant, although this improved from the previous quarter’s contraction of 0.5%. Meanwhile, annual inflation in Germany eased to 7.6% in April due to lower energy prices, while France accelerated consumer prices to 6.9%, and Spain’s headline inflation rate rose to 3.8%. The UK economy showed no growth in February, held back by widespread industrial action and persistent inflation. GDP in February missed consensus expectations of 0.1% growth as the services and production sectors contracted, despite a 2.4% expansion in construction. Large-scale strikes have taken place in recent months, involving teachers, doctors, civil servants, and rail workers, which have had a notable impact on different industries, mainly the services and industrial production sectors. The UK is now the last major economy to recover its pre-pandemic output levels. The International Monetary Fund has projected that the UK GDP will shrink by 0.3% in 2023, making it the worst performer in a G-20 that includes war-waging Russia.
The Portfolio Management Team