Market Watch: July 2023

Global financial markets saw a positive upswing in July due to declining developed market inflation and resilient GDP data, raising hopes for a soft landing and prompting a broad rally across various assets and regions. The Federal Reserve raised its key policy rate as expected, and the June CPI print was a major market mover, impacting inflation expectations. The dollar declined, and the European Central Bank also raised rates while considering a pause in September. The UK saw elevated wage data and softer inflation, with expectations of a Bank of England rate hike. Chinese markets gained thanks to policy easing and stimulus hopes. Investor optimism remained high, but uncertainties regarding inflation and economic activity persisted.

The S&P/TSX Total Return Index was up 2.58 percent in July as Canada’s economy contracted amid weakening growth prospects, prompting BoC’s second consecutive interest rate hike.

Canada’s economy experienced a 0.2 percent decline in June, marking the first contraction in the current year. Decreases in the wholesale and manufacturing sectors primarily drove this contraction. The previous month, May, saw a 0.3 percent expansion, aligning with economists’ expectations. This growth rate is slower than the Bank of Canada’s initial projection of 1.5 percent and considerably weaker than the 3.1 percent growth recorded in the first quarter of 2023. The report indicates that Canada’s economy is heading towards a milder growth phase, with a projected slowdown in consumption spending in the latter half of the year due to weakening demand for interest-sensitive goods and services and households renewing mortgages at higher rates.

Canada’s labor market remained strong, but there were mixed indicators for the overall economy in June. Record immigration numbers positively impacted employment growth and eased supply-side pressures in the labor market. However, the employment growth was insufficient to accommodate the rapid workforce expansion. Tighter financial conditions increased the unemployment rate from 5.2 percent to 5.4 percent, with Canadian firms experiencing varying profit margin compression.

Canadian headline inflation in June was 2.8 percent year-on-year, lower than the anticipated 3.0 percent, mainly due to reduced energy prices. West Texas Intermediate crude oil and gasoline prices decreased by around 32 percent and 22 percent compared to the previous year. However, inflationary pressure persists as food and mortgage interest costs remain significant drivers of inflation, with mortgage interest costs rising by 30 percent year-on-year. Despite this, consumer spending has shown resilience, indicating a broader inflationary trend in the Canadian economy.

On monetary policy, the Bank of Canada (BoC) has implemented a second consecutive 25 bps interest rate hike, raising the overnight rate to 5.00 percent due to mounting concerns about inflation surpassing the 2 percent target. Although headline inflation decreased to 3.4 percent in May from last year’s peak of 8.1 percent, core measures have remained stagnant, and strong wage growth persists. The BoC anticipates slower GDP growth but expects excess demand to continue into 2024, resulting in approximately 3 percent inflation for the next year. Economists predict that high-interest rates will persist throughout 2023, with a potential for one more rate hike before year-end. Economists anticipate rate cuts in the second half of 2024, though they may be gradual if implemented.

The S&P 500 Total Return index was up 3.21 percent in July as US Economy surged in Q2 with 2.4 percent annual growth; inflation slowed to 3 percent in June; the Federal Reserve raised rates amid labor market resilience.

The US economy experienced a significant boost in the second quarter, with an annual growth rate of 2.4 percent. This unexpected acceleration was supported by strong consumer spending and certain types of investments. Despite the Federal Reserve’s efforts to combat inflation through rising interest rates, the economy showed resilience. The GDP growth surpassed earlier expectations, exceeding the 2 percent rate recorded in the first three months of 2023. Consumer spending outperformed forecasts, growing at a 1.6 percent pace following a surge at the beginning of the year. However, investment in housing declined due to the impact of higher mortgage rates. Economists had previously expressed concerns about a potential slowdown, given the central bank’s rapid interest rate hikes over the past year to manage demand and control inflation. The latest growth figures were influenced by an upturn in private inventory investment and an increase in nonresidential fixed investment. Still, these gains were partly offset by decreased exports and slower consumer and government spending.

The US labor market experienced slower-than-expected job growth in June, following a surge in the previous month; however, the labor market continues to show strength, with the unemployment rate declining from a seven-month high and steady wage gains. Nonfarm payrolls increased by 209,000 jobs last month, while May’s data was revised downward to show 306,000 payrolls instead of the previously reported 339,000. Economists had predicted a rise of 225,000 jobs. Despite the slowdown in job growth, the unemployment rate decreased to 3.6 percent from May’s 3.7 percent. The labor market’s resilience is noteworthy, given the Federal Reserve’s aggressive monetary policy tightening since March 2022, involving 500 basis points worth of rate hikes, the fastest in over four decades.

The inflation rate in the US plummeted to 3 percent year-over-year in June, indicating that the Federal Reserve’s efforts to control surging prices have had a positive impact. The Consumer Price Index (CPI) experienced a 3 percent annual increase in June, the smallest rise over two years. Although core inflation, which excludes food and energy price changes, remained above the Federal Reserve’s target at 4.8 percent year-over-year, it was significantly lower than the 6 percent increase recorded in November 2022. Shorter-term inflation trends also showed promising progress, with overall and core prices rising by 0.2 percent month-over-month, falling below economists’ expectations according to a pre-release survey by Bloomberg. This price increase could align with the Federal Reserve’s inflation-targeting regime if sustained.

On monetary policy, The Fed implemented its 11th rate increase, raising the benchmark lending rate by a quarter point to 5.25 percent-5.5 percent, the highest level in 22 years, as part of its ongoing efforts to combat inflation since March 2022. The decision came after a brief pause to evaluate the economy following the failures of three regional banks. Although inflation has shown signs of slowing down, Fed officials remained cautious, stating that inflation remains elevated and the central bank will continue to monitor inflation risks closely, leaving the possibility of another rate hike open. Fed Chair Jerome Powell emphasized that additional rate increases may be necessary if the economy strengthens and inflation persists. The preferred inflation gauge, the Personal Consumption Expenditures price index, decreased to 3.8 percent in May from the prior month’s 4.3 percent, while the core measure slightly decreased to 4.6 percent, the lowest level since October 2021. Investors are optimistic about a soft-landing scenario, where inflation reaches the 2 percent target without major economic consequences, but Powell warned about potential labor market softening. The timing of the final rate hike remains uncertain, dependent on data and the persistence of inflationary pressures.

The MSCI ACWI Ex-US Total Return Index was up 3.92 percent in July as China’s Q2 GDP growth missed expectations, Eurozone saw a slight improvement, and ECB raised interest rates due to rising inflation.

China’s economy grew 6.3 percent in the second quarter compared to last year. Still, this growth fell short of market expectations due to weak export demand and declining property prices, negatively impacting consumer confidence. The country’s GDP for April to June was 6.3 percent larger than the previous year, showing an improvement from the 4.5 percent growth in the first quarter of 2023. However, economists had anticipated a faster growth rate of 7.3 percent. In terms of quarterly performance, the growth rate in the June quarter slowed to 0.8 percent, down from 2.2 percent in the March quarter, yet still exceeded predictions of a 0.5 percent expansion.

In the Eurozone, recent inflation figures have emerged amid sluggish economic growth, with GDP remaining stagnant in the first quarter of the year. Nevertheless, there was a slight improvement in the second quarter as GDP expanded by 0.3 percent, surpassing the 0.2 percent forecast by analysts polled by Reuters. However, some analysts believe this growth is misleading due to one-off boosts in France and Ireland, which do not reflect the economy’s underlying strength. They argue that if these exceptional factors are excluded, GDP growth would have been only 0.04 percent quarter-on-quarter or close to zero. He predicts that the euro-zone GDP will contract in the year’s second half, especially considering the tightening of monetary policy. France and Ireland were relatively resilient during this period, with the former showing a GDP rate of 0.5 percent and the latter expanding by 3.3 percent. However, analysts warn that the overall growth would have been significantly reduced without Ireland, and the economy appears to remain broadly stagnant. As for the third quarter, survey data indicates potential downside risks. While Spain saw a growth of 0.4 percent, Germany’s performance was weaker, failing to record any growth during the same three-month period.

The European Central Bank (ECB) has raised interest rates by 25 basis points to 3.5 percent and announced the end of reinvestments under its Asset Purchase Program, as anticipated by the markets. The ECB acknowledges that although inflation is slowing down, it is still projected to remain high for an extended period. Inflation forecasts have been revised upwards, indicating potential rate hikes to 4 percent. The staff projection for core inflation has significantly increased this year and the next, with catch-up adjustments to account for recent unexpected inflation data. Similarly, the Bank of England’s surprise interest rate hike of 50 basis points reflects deep concerns among the voting members of the Monetary Policy Committee. The decision was driven by higher-than-expected inflation and wage data, with inflation consistently exceeding consensus expectations for the past four months.

The Portfolio Management Team