Market Watch: January 2023

Global financial markets had a strong start in January with positive gains. The US economy showed signs of growth while the inflation rate slowed down. The Euro Area economy expanded at a weaker pace, with decreasing inflation and hawkish rhetoric from ECB policymakers. China’s economy also showed positive growth with the lifting of COVID-19 restrictions and prospects for further support from Beijing. Commodities such as gold and copper performed well while the oil price remained stable.

The S&P/TSX Total Return Index was up 7.1% in January after the Bank of Canada raised the interest rate to 4.5%. Markets expect the hike cycle to end soon amid mixed economic indicators.

Canada’s economy slowed down at the end of 2022, with GDP being flat in December, following a 0.1% gain in November. The monthly gains suggest an annualized growth rate of 1.6% in the fourth quarter, down from a 2.9% pace in the third quarter. The slow growth is due to decreases in the wholesale, finance, and oil and gas industries, which offset increases in retail, utilities, and the public sector.

The job market saw a significant increase in jobs and a surprising decrease in the unemployment rate in December. The economy gained 104,000 jobs, surpassing expectations, while the jobless rate dropped to 5% from 5.1% in November. The job growth was driven by full-time employment and was widespread across industries. The average hourly wage for permanent employees increased 5.2% YoY in December, though it was a slower growth compared to November’s 5.4% YoY.

Canada’s Consumer Price Index (CPI) inflation rate slowed to 6.3% YoY and declined 0.5% MoM in December. The decrease in inflation was due to a fall in gasoline prices, which decreased 13.1% MoM, and a slowdown of price increases in durable goods. However, service prices remained high, particularly in the housing market, with rising mortgage costs pushing prices up by 18% YoY.

On monetary policy, the Bank of Canada raised its benchmark overnight interest rate by 25 basis points to 4.5% at its latest policy meeting. Financial markets expect this to be the last hike of the cycle by pricing in nearly 50 bps of cuts for the second half of 2023. BoC Governor Tiff Macklem appeared dovish, acknowledging that while nominal economic growth and labor market conditions are still strong, tighter monetary policy has weakened household consumption and housing market activity.

The S&P 500 Total Return index was down 5.9% in December after the Fed increased interest rates and moved closer to ending the hiking cycle. Experts predict a pivot to economic stimulus later this year.

The US economy expanded faster than expected in Q4 2022, growing at an annualized pace of 2.9%. This was higher than the expected 2.6% growth and shows a slowdown from the 3.2% growth in the previous quarter. For the full year, GDP increased by 2.1% compared to 5.9% in 2021, the fastest pace since 1984. The growth in Q4 was attributed to private inventory investment, consumer spending, government spending, and nonresidential fixed investment while being partially offset by declines in residential fixed investment and exports.

The economy experienced steady employment growth in December, with an increase of 223,000 nonfarm jobs and a drop in the unemployment rate to 3.5%. This was higher than the expected 200,000 jobs growth forecast by economists. Despite the Federal Reserve’s fast interest rate hike since March, the labor market has remained robust, with some industries, such as leisure and hospitality, struggling to find workers, while others, such as finance and technology companies, have had to lay off employees. The strong labor market has been supporting consumer spending. However, this trend may slow down by mid-year due to the burden of costly credit on consumer spending and business investment.

The December Consumer Price Index (CPI) report showed that inflation pressures are easing, leading to the belief that the peak of inflation has already passed. The YoY headline CPI inflation rate for December was 6.5%, as predicted by analysts, and the YoY Core CPI inflation rate was also as expected at 5.7%. These recent data, along with previous months’ lower-than-expected readings, indicate that inflation is decreasing. In December, producer-level inflation decreased the most since the start of the pandemic. The decline in the Producer Price Index was mainly caused by the decrease in food and energy prices, while core prices slightly increased, though they are still 1.3% lower than the previous year.

On monetary policy, The Federal Reserve has increased its benchmark interest rate by 0.25% in its ongoing efforts to control inflation. This is the smallest rate hike since March and was expected, bringing the rate to a range of 4.5% to 4.75%. The Fed is gradually moving closer to ending its current cycle of interest rate hikes, which aim to combat inflation by making borrowing more expensive. Although the Fed has made progress against inflation, officials have indicated that there may be future hikes. The Fed faces a challenging task in balancing interest rates and controlling inflation while avoiding a recession. Throughout 2022, the Fed was focused on reducing inflation, which has cooled in recent months. Economists predict that the Fed will shift from inflation-fighting to economic stimulus mode and start cutting interest rates in the third quarter of the year.

The MSCI ACWI Ex-US Total Return Index was up 8.9% in January after the IMF revised its global growth outlook for 2023 upwards, while central banks raised interest rates.

The IMF has revised its 2023 global growth projections upward, citing resilient demand in the US and Europe, and China’s economy reopening after dropping its strict zero-COVID strategy. Although the global growth rate will still decrease from 3.4% in 2022 to 2.9% in 2023, it is better than the previous prediction of 2.7%. The IMF predicts a slight acceleration to 3.1% in 2024. However, central bank interest rate hikes are expected to slow demand. The IMF Chief Economist, Pierre-Olivier Gourinchas, stated that while the recession risks have declined, more work is needed to control inflation, and new disruptions could arise from the escalation of the conflict in Ukraine and China’s COVID-19 situation. The IMF predicts the US GDP to grow by 1.4% in 2023, with the eurozone growing 0.7% and China growing 5.2%. The only major advanced economy expected to be in recession this year is the UK, with a projected 0.6% decline in its economy.

The inflation data in Europe is showing improvement, with the December YoY inflation rate declining in France, Germany, and Italy. The decline in inflation is due to lower energy prices and mild weather. While the UK still struggles with inflation as food prices have increased, and there are still wage pressures and strikes. The ECB is still concerned about inflation above the 2% target, despite declining inflation expectations, and some members have made hawkish statements about rates rising. Economists predict that 2023 inflation to reach 7.3% by the end of the year before reaching 2.1% in 2024. The ECB sees inflation expectations declining, but some members are still concerned about inflation above the target of 2% and have made hawkish statements. Despite these comments, market expectations have not changed, and the expected policy rate remains around 3.30%.

The ECB and BOE raised interest rates by 0.5% as part of their effort to control inflation. While the ECB signaled the likelihood of further rate hikes in the future, the BOE gave a more positive outlook and hinted at the possibility of pausing future rate increases. The BOE’s governor, Andrew Bailey, acknowledged improvement in inflation but warned of ongoing risks. He also noted that the central bank would assess the situation and determine if further rate hikes are necessarily based on evidence of persistent inflation.

The Portfolio Management Team