With Canadian inflation still overshooting consensus estimates, its possible the Bank of Canada will raise the interest rate more than 50 basis points (bps) at its next meeting. The greenback reached a new high this week, buoyed by surging US Treasury yields. Meanwhile, the loonie outperformed most of its major peers but struggled against the US currency as the US Federal Reserve’s monetary policy keeps pace with the Bank of Canada. While there are some bright spots for first-quarter earnings results, overall, the way forward is expected to be a tougher go.     

Scotiabank analysts and economists weigh in on how economic indicators and trends are influencing currencies, retail and equities right now.

Inflation

  • Canadian inflation overshot even my above-consensus estimate for March and with eye-popping breadth. The fact that inflation is running amok should drive at a minimum the 50-bps hike we forecast at the BoC’s next meeting in June, and there is a solid case for a 75- or 100-bps hike in one shot.
  • The BoC's slowness to act is a big part of how we got inflation numbers like these. Monetary policy tailored to current conditions should already be at neutral — if not above that — given where inflation is and with a full employment recovery as the economy has moved into excess aggregate demand. Having failed to deliver that outcome, the second-best option is to get to the mid-point of the 2% to 3% neutral rate range, preferably by July, or the next two to three meetings.
  • Headline inflation at 6.7% year-over-year is at its hottest since January 1991 but just wait until next month. Month-over-month, inflation for Q1 is somewhat above the BoC’s revised forecasts published just a week ago. At the time they forecast inflation of 5.6% and the quarter landed at 5.8%. Statistics Canada is finally adding used vehicle prices to the CPI index next month. Whether they incorporate used vehicle prices into historical numbers or just on a go-forward basis, it will still leave inflation running over 8% above the year earlier figure. That should end the illusion that Canada has been managing inflation better than the US and other countries.
  • Serial supply shocks, plus hot demand, a net move into excess aggregate demand, idiosyncratic factors, an upward shift in secular forces, rising inflation expectations and carbon pricing are all driving inflation higher now, and in the future. To dismiss this full list by saying it’s just supply-side factors and that policy shouldn’t be tightening is an absurdly stale, outdated assessment that hasn’t shifted with the times.

 —  Derek Holt, Vice-President and Head of Capital Markets Economics 

Foreign Exchange

  • This week, the US dollar reached a new high since the pandemic shock thanks to the support of surging US yields amid continued hawkishness from the US Federal Reserve. On Wednesday, the 10-year Treasury note yields neared the 3% mark in nominal terms and touched the 0% level in real terms as markets price in almost three consecutive 50-bps hikes from the Fed. There is some speculation that the Federal Open Market Committee may vote for a 75-bps hike at one of its upcoming meetings. The yen (JPY) neared the 130 level this week as surging US yields, an ultra-dovish Bank of Japan that continues to aggressively defend its 10-yr yield target, and weak Japanese terms of trade keep downward pressure on the currency.
  • Much stronger than expected Canadian consumer price index data for March helped the Canadian dollar outperform most of its major peers over the week with gains on Thursday extending to the mid-1.24s per USD. Canadian inflation came in at 6.7% year-over-year versus a median forecast of 6.1%, with prices rising by 1.4% month-over-month, compared to expectations of a 0.9% gain. Year-over-year increases in core prices are also averaging almost double the Bank of Canada’s target across the bank’s preferred measures. Odds are rising that the BoC delivers at least two more 50bps hikes — at its June and July meetings — with some considering the possibility of a 75bps increase at one of its upcoming decisions. BoC Governor Tiff Macklem’s address in Parliament on Monday will be closely monitored for comments that suggest the possibility of large hikes continuing — or that of a 75-bps (or even a very aggressive 100-bps) hike.
  • The CAD has capitalized on climbing yield differentials against low-yielding currencies such as the yen and Swiss franc (CHF), however, gains have proven a bit limited against the euro (EUR) this week as markets begin to price in three 25-bps hikes from the European Central Bank — with the first expected in July — following hawkish comments from ECB officials. The CAD’s appreciation versus the USD has struggled somewhat as the Fed is also set on a steep tightening course, but the Canadian currency is enjoying the support of strong terms of trade that should set USDCAD toward a re-test of the 1.24 in the near term.

—  Shaun Osborne, Managing Director, Chief FX Strategist, and Juan Manuel Herrera, FX Strategist 

Equities

  • End of the earnings party. According to the Street, first quarter earnings per share (EPS) on the S&P 500 should dip 7% sequentially, coming off an all-time high (US$55.03) hit last quarter. The Q1/22 year-over-year expansion rate of 4.9% also marks a visible slowdown from an exceptional four consecutive quarters of 30%+ y/y growth. In our view, the expected sequential dip is not overly concerning for now. While we expect positive surprises to carry the final EPS tally higher, we would not expect such a negative contraction to be erased. Tepid corporate guidance and negative revisions in key sectors (technology) are some headwinds arguing against a strong beat.
  • Profit headwinds for most cyclicals. Among sectors not affected by seasonality, energy (+13%) and healthcare (+4.5%) are the only ones that should deliver sequential EPS growth in the first quarter. Looking at year-over-year growth trends, we note that resource sectors dominate. While industrials continue their recovery, EPS trends in other cyclical sectors have moderated much faster: both financials and discretionary flip to negative year-over-year growth and technology slows to single-digit growth rate. Given the conflict in Ukraine, lockdowns in China, and the steep rise in the dollar index, keep an eye on companies boasting high foreign revenue exposure.
  • Overall, turbocharged earnings growth that lasted from third quarter 2020 to fourth quarter 2021 has ended and the way forward is likely to be a tougher slog. Still, as with bottom-up consensus, we do not anticipate an outright earnings contraction for 2022, only a slowdown from above-average growth levels.

—  Hugo Ste-Marie, Director Portfolio & Quantitative Strategy; Jean-Michel Gauthier, Associate Director, Portfolio & Quantitative Strategy

 

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