Global financial markets were resilient in the first quarter of 2023, with stocks gaining despite the banking crisis and economic uncertainty. Bond prices also rose as investors wagered that the central banks would not raise rates as high as anticipated. Despite the strong performance, investors worry that inflation remains a key factor driving markets and could cause turbulence. The collapse of three financial institutions set off a banking meltdown earlier this year, but markets largely shrugged it off. The Fed also drove much of the narrative with a 25bps hike to balance the risk of inflation.
Canada
The S&P/TSX Total Return Index was down 0.6 percent in March as the Canadian economy grew, unemployment remained unchanged, and the inflation rate decreased.
GDP grew by 0.5% in January 2023, exceeding market expectations of a 0.3% increase and rebounding from the 0.1% contraction in December 2022. The rise in GDP was driven by growth in the mining, oil and gas extraction, manufacturing, and finance and insurance sectors, partially offset by decreases in construction, wholesale trade, and food services. The economy had stalled in the final quarter of 2022, following five consecutive quarters of growth. However, the advance figures for February indicate a continued expansion, with real GDP rising by 0.3%.
The Canadian economy added 22,000 jobs in February, with an unchanged unemployment rate of 5%. This was better than market expectations, which anticipated an unemployment rate of 5.1%. The health care and social assistance sector saw the largest employment growth with a rise of 0.6%, followed by public administration with a gain of 0.9%. Additionally, total monthly hours worked increased by 0.6%, and average hourly wages rose by 5.4% year-on-year, accelerating from a 4.5% gain in January.
The Canadian inflation rate decreased to 5.2% in February, marking the largest slowdown since April 2020. This figure represents a year-on-year deceleration from February 2022, when inflation was 5.7%. The latest reading is the lowest since January 2022, at 5.1%. The fall was attributed to a sharp monthly price increase in February 2022, when the Russian invasion of Ukraine greatly impacted the global economy. This decline aligns with the expectations of economists who anticipated a deceleration in inflation as supply chain disruptions caused by the COVID-19 pandemic ease.
On monetary policy, the Bank of Canada left its key overnight interest rate at 4.50%, halting its monetary tightening campaign in response to expected decreases in high inflation. It raised interest rates eight times in the past year, by a total of 425 basis points, to address inflation, which peaked at an annualized rate of 8.1% in 2022 and slowed to 5.2% in February 2023, still nearly three times the Bank of Canada’s 2% target. The central bank has stated that it will not raise rates further if inflation slows per its projections, reaching 2% next year. Recent events, such as the collapse of US regional banks and the Swiss government’s mediation in the deal between UBS and Credit Suisse, highlight the pressures on the global banking sector that central banks must consider when making policy decisions. Despite predictions that the Bank will maintain interest rates at their current level during its next meeting on April 12, the market expects a cut later this year, partly due to the recent turmoil in the banking industry.
US
The S&P 500 Total Return Index was up 3.85 percent in March following a US Q4 GDP miss, strong job growth, a cooldown of inflation, and a 25bps Fed rate hike.
The US economy experienced slower growth in the fourth quarter of 2022 than initially predicted, as consumer spending decreased. The GDP increased by 2.6%, missing the target of 2.7%. This decrease follows the 3.2% annualized growth in the third quarter. The step back in growth can be attributed to decreasing consumer spending, downturns in exports, nonresidential fixed investment, and state and local government spending. Oxford Economics predicts a mild recession in the second half of 2023. Goldman Sachs has lowered its outlook for economic growth in 2023 from 1.5% to 1.2% due to the collapse of Silicon Valley Bank.
The US economy added 311,000 jobs in February, surpassing market expectations, although the unemployment rate rose to 3.6%. This indicates that the job growth observed in January was not a one-off event, as some had speculated. Economists believe that the economy needs to generate 100,000 jobs each month to keep up with growth in the working-age population. Despite layoffs in the technology sector, first-time applications for unemployment benefits have remained low, indicating a tight labor market. Economists caution that January’s hiring surge may have been influenced by various factors, including unseasonably warm weather and generous seasonal adjustment factors.
The latest Consumer Price Index (CPI) report indicates that inflation continues to slow down. The annual price increase measured by the CPI was 6% for the year ending in February, a decrease from January’s 6.4%. This marks the eighth consecutive month of declining annual rates and the lowest level since September 2021. Monthly price growth also slowed in February, with prices increasing by 0.4%, compared to 0.5% in January. This was in line with economists’ expectations. The report also shows that inflation at the producer level unexpectedly fell in February, indicating that cost pressures for wholesalers are easing due to improving supply chains and falling commodity prices. Final demand figures slipped 0.1% month-on-month, and levels increased 4.6% year-on-year, both below forecasts. Declining food prices mainly drove the slowdown in inflation for the third consecutive month, while energy prices also edged lower.
On monetary policy, The Federal Reserve has increased its benchmark interest rate by 0.25% for the second time this year to tackle high inflation and financial instability. This has resulted in a range of 4.75% to 5%, the highest rate since 2007, and marks the ninth consecutive rate hike. While investors and economists had anticipated the move, recent banking sector turbulence has increased uncertainty around the decision. The Fed acknowledged that recent market turmoil could impact inflation and the economy but expressed confidence in the overall system. However, the collapse of several banks has made the Fed’s mission of battling inflation more challenging. The decision to raise rates was unanimous, but the Fed has also projected deeper economic cuts over the next two years. While interest rates are likely to remain higher for longer, current financial conditions suggest less need to hold rates high to cool the economy and curb inflation.
International
The MSCI ACWI Ex-US Total Return Index was up 3.06 percent in March after UBS acquired Credit Suisse; inflation and interest rates remain major concerns in Europe.
As regulators pushed for a takeover to avoid further market disruption, UBS, a Swiss banking giant, will acquire Credit Suisse for $3.25 billion. Swiss authorities and the central bank are extending a credit line of up to CHF 100 billion to UBS and Credit Suisse. Credit Suisse is designated a globally systemic important bank by the Financial Stability Board, meaning its failure could cause ripples throughout the financial system. While the collapse of two US banks last week has heightened concerns, the unique problems facing Credit Suisse do not necessarily signal a broader financial crisis.
Inflation in the Eurozone has slowed to 6.9% YoY, the lowest since February 2022, mainly driven by a decline in energy prices. However, there are persistent upward pressures on prices, particularly in food, alcohol, tobacco, and services, which may complicate the European Central Bank’s (ECB) decision on interest rates. Core inflation, which excludes volatile food and energy prices, reached a new record high of 5.7% in March. The recent banking sector turmoil has also highlighted the risks of rapid interest rate hikes to the economy and the financial system. Furthermore, Europe’s economic growth may face additional risks from banks’ efforts to preserve cash following recent bank failures in the US and Europe.
The Bank of England and the European Central Bank (ECB) have increased their benchmark interest rates to combat inflation. The Bank of England raised rates by 0.25 percentage points to 4.25%, its 11th consecutive rate hike, citing stronger-than-expected GDP growth and higher-than-expected inflation. Due to rising inflation, the ECB raised rates by 0.5 percentage points to 3%, its sixth consecutive rate hike since July 2022. Both central banks are monitoring the impact of the banking sector’s turmoil on credit conditions, although the ECB views inflation as a bigger threat. The ECB projects inflation to be an average of 5.3% in 2023, down from its previous projection of 6.3%. ECB President Christine Lagarde emphasized the importance of economic data in making policy decisions and stated that the bank’s determination to fight inflation remained intact.
The Portfolio Management Team