Encouraging inflation data created a note of optimism that this interest rate tightening cycle is peaking. The narrative is how central banks can engineer a so-called Goldilocks scenario of cooling the economy without mis-stepping and becoming overly restrictive. Not too hot, not too cold. The concern is that inflation becomes ingrained and lasts longer than expected. Soft landing, hard landing, no landing? Recession risks remain and although the S&P500 is up over 20% since its October 2022 low much of this has been driven by the AI theme and seven mega cap tech stocks.
As widely expected, the Bank of Canada (BoC) raised rates by 0.25% in July and the benchmark rate now stands at 5%. Canada’s headline inflation for June came in at 2.8% year-over-year, following an inflation rate of 3.4% in May. According to Statistics Canada the base year effect in gasoline prices led the slowdown in the headline rate. Base year effects refer to comparisons made today with elevated levels of a year ago when we were paying more at the pump. Food inflation still remains high though, and has yet to come down. Core inflation, which is closely watched and excludes food and energy prices, is still tracking above target at 3.9% on a yearly basis.
Similarly in the US, the Fed also hiked by a quarter percentage point to the highest level in 22 years. June CPI was the lowest in over two years but core inflation also remains high, suggesting harder to crack underlying price increases. There was a slight jobs miss in the US June employment report but solid enough to show a still resilient economy. The labour market is strong and consumers have shown an ability to absorb higher prices. The thinking is that rates will need to stay higher until they have the desired effect on consumption and hiring.
In Europe, the ECB raised rates for the ninth time in a row. The door has been kept open for further tightening although signaling they are becoming more data dependent. Europe is showing signs of manufacturing contraction and potential weakness ahead. The UK is still struggling with high core inflation, although June inflation data was lower than expected.
Added to the mix are geopolitical risks including the Ukraine war, and tensions between the US and China. US Treasury Secretary Janet Yellen visited Beijing as part of the ongoing process to help smooth relations between those countries. However, it was noteworthy that China have placed export restrictions on two key components used in semiconductor manufacturing. The Chips Act in the US has restricted companies selling semiconductor chips and technology to China and promotes companies manufacturing chips in the US.
Overall, the inflation picture is getting better and there is growing optimism it has passed its peak. Despite this, there is no sign of rates coming down any time soon. While the soft landing thesis for the US economy has helped prop up equity markets uncertainty remains until it becomes clearer what type of landing there will be and what any slowdown will look like. Staying diversified is the key to navigating through it. At ModernAdvisor we offer broadly diversified portfolios of equity and fixed income for a variety of risk tolerance levels.