A big jump in the Consumer Price Index for food at home last year isn’t news to shoppers but, as always, grocers will need to be mindful of their pricing decisions in order to balance profitability, market competitiveness, and customer loyalty. The US dollar got support this week from the surge in bond yields after the US Federal Reserve bumped up the key interest rate 25 basis points and signalled there were more hikes to come. Despite the USD strength, the loonie has put on a strong performance over the past two weeks, gaining 2.3%. Steadier markets, strong domestic growth and high commodity prices could leave room for further improvement in the Canadian currency near-term. Meanwhile, good news in the “Confidence and Supply Agreement” confirmed this week by the federal Liberals and NDPs gave Real Estate Investment Trusts (REITs) a little breathing room to further educate key constituents on the role Apartment REITs play in providing affordable and quality living. Finally, while there may be some similarities in the current investing environment with the 1970s, investors shouldn’t worry because we are nowhere near calling it a new stagflation era.
Scotiabank analysts weigh in on how economic indicators and trends are influencing retail, currencies, REITs and equities right now.
Retail
- The Consumer Price Index (CPI) for food at home recorded its largest yearly increase since May 2009, driven by higher prices in all significant food categories, and especially meat. CPI food at home rose 7.4% in February and was up 1.5% month over month. The year over year change in meat prices was 11.7%, with beef seeing the biggest increase. Overall, the CPI for February was up 5.7% y/y (4.7% excluding gas), with broad-based price increases in goods and services — the most prominent growth contributors being gasoline, groceries, and shelter. As always, grocers will need to be mindful of their pricing decisions in order to balance profitability, market competitiveness, and customer loyalty.
- Food inflation overall was 6.7% in February, accelerating from 5.7% in January. Prices for food bought in restaurants rose 4.7% year over year, compared with a 4.1% increase in January. High commodity costs and labour shortages continue to be the top industry challenges pressuring restaurant economics. In addition to passing the cost increases on to customers directly, industry players are looking to attract and retain staff, simplifying operational processes, scaling down menus and cutting value items.
- Supply chain challenges, weather-related increases in agricultural prices, and higher energy prices are expected to contribute to high inflation in Canada over the coming months. While some supply chain bottlenecks might be easing as Omicron fades, the invasion of Ukraine is putting upward pressure on prices for energy and food-related commodities. The strength in the economic recovery in Canada has also driven inflation. Having raised the policy rate by 25 basis points this month, the Bank of Canada continues to expect inflationary pressures to ease in the second half of 2022.
— Patricia Baker, Director, Retailing, Global Equity Research
Foreign Exchange
- The US Federal Reserve duly kicked off its tightening cycle last week with a rate increase of 25 basis points (bps). Subsequent messaging from key policy-makers, including Fed Chairman Jerome Powell, strongly suggested that the pace of monetary tightening will pick up amid heightened concerns over rising inflationary pressures and that a 50bps hike in the coming months cannot be ruled out. The communication exercise is a deliberate ploy to encourage markets to price in more tightening — so it is less of a shock when it occurs — and has been successful; markets have priced in a roughly 70% risk of a 50bps increase in May now, which gives the Fed a green light to hike aggressively at its next meeting. That may not be the last of the 50bps hikes, however; policy-makers clearly feel they are behind the curve and that they need to raise rates quickly to curb price pressures.
- Resulting surge in US yields supports the US dollar. The US 2-Year bond yields have risen about 70bps since the start of March, providing the USD with essential support against lower-yielding currencies, in particular. The yen is near 121.50, its weakest level since 2016, while the euro is below 1.10. For both currencies, the war in Ukraine is an additional headwind. Rising commodity prices are a negative for the yen, given that Japan imports significant quantities of raw materials (resulting in a surge in import costs and a deteriorating trade balance). Medium-term, we remain bullish on the outlook for the USD against the lower-yielding currencies.
- The Canadian dollar has been a solid performer over the past two weeks, rising 2.3% against the USD. USDCAD has been consistently capped in the 1.28/1.29 range since the start of the year and CAD gains partially reflect a move to the lower end of the USD’s trading range. Risk assets have stabilized after the initial shock of the Russian invasion, however, and have digested the more aggressive Fed policy stance well. This has allowed broader measures of market volatility (such as the Chicago Board Options Exchange Volatility Index) to ease, supporting the CAD. In addition, economic data suggest the Canadian economy is growing strongly in Q1 which implies the Bank of Canada is likely to keep pace, more or less, with Fed rate increases in the coming months. We think the combination of steadier markets, strong domestic growth and high commodity prices are opening the window for a little more CAD improvement in the coming weeks; a push under USDCAD support at 1.2575 should see the USD fall back to the 1.24 area in the short run. Seasonal trends may also be a factor; April is the worst month for the USD (versus the CAD) with the month’s returns averaging -1% over the past 25 years.
— Shaun Osborne, Managing Director, Chief FX Strategist, and Juan Manuel Herrera, FX Strategist
Real Estate & REITs
- Lowering the odds of punitive REIT measures within the budget. The biggest highlight for the Residential REITs we see in the “Confidence and Supply Agreement” confirmed this week, which would see the New Democratic Party support the Liberal Party of Canada's minority government until 2025 in exchange for a commitment to act on key NDP priorities, was the federal government’s note it plans to “tackle the financialization of the housing market” by the end of 2023 (no timetable previously), something we felt could be in the upcoming Budget. We think the longer timetable lessens a near-term headwind for CAD Apartment REITs while providing the industry with an opportunity to further educate key constituents on the role Apartment REITs play in providing affordable and quality living. On the downside, the announcement delays the regulatory clarity surrounding operational and structural parameters we think is critical for owners.
- The Liberals provided few details on plans to “curb” excessive profits in residential real estate in the run up to the election last year, leaving investors to ponder the extent of the policy review. CAD Multi-family REITs have lagged the broader REIT space since (+0.6% vs. +5.3%), which we in part attribute to market uncertainty over the regulatory environment (federal and pending Ontario election).
- Proposal for a landlord surtax. In an update to the Federal Housing Mandate Letter on Dec. 16 there was a proposal to “introduce amendments to the Income Tax Act to require landlords to disclose in their tax filings the rent they receive pre- and post-renovation and to pay a proportional surtax if the increase in rent is excessive”. The size of the “surtax” and definition of “excessive” is unknown.
— Mario Saric, Managing Director, Real Estate & REITs Equity Research; Romel Sabat, Associate, Real Estate & REITs Equity Research; Viktor Fediv, Associate, Real Estate & REITs Equity Research
Equities
- Revisiting the 1970s in charts. Investors’ interest in the stagflation era has never been so high. With the conflict raging in Ukraine, some worry that current macro conditions could lead to a new stagflation era. Investors are concerned that sanctions, trade disruptions and COVID could bite into global growth just when the Fed starts its tightening cycle, while spiking commodity prices and supply chain issues could lift inflation further for longer. Given that the majority of professional investors were not actively trading during the 1970s, we thought it would be interesting to revisit what was a challenging, but uneven, decade for investors.
- Persistently high inflation, sub-par growth and high unemployment defined the 70s. While we understand the reference to the decade (burst in commodity prices; highest inflation in four decades), we believe it’s somewhat misleading. The current expansion phase would have to materially disappoint to get what we would call a light version of the 70s. We’re not saying it can’t happen, but the odds are still low, in our opinion.
- A challenging, but uneven, decade for investors. Stocks generated mediocre returns during the 70s, with the S&P 500 rising only 17% between 1969 and 1979. That translates into a paltry 10-year CAGR performance of 1.6%. The TSX gained 78% over the same time frame, implying a 10-year CAGR of 5.9% (local currency). Despite anemic returns over the full period, equities experienced a lot of volatility, with periods of strong gains.
— Hugo Ste-Marie, Director Portfolio & Quantitative Strategy; Jean-Michel Gauthier, Associate Director, Portfolio & Quantitative Strategy; and Simone Arel, Research Associate, Global Equity Research
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