There is no sign core inflation in the United States is slowing, with the exception of a few categories in the consumer price index softening, and that means interest rates will continue to rise along with treasury yields. The U.S. dollar rally, though it looks stretched, shows little sign of weakening but other central banks are pushing back with interventions to slow weakening currencies, particularly in Japan, Chile and China. Firm oil prices and a hawkish Bank of Canada are keeping the loonie trading at relatively firm levels against other G10 currencies, but USDCAD gains have extended further. Firmer stocks could lift the Canadian dollar, but it remains at risk of further weakness from rising rates and geo-political tensions. Meanwhile, Scotiabank’s Canadian spending tracker, based on Scotiabank’s daily spending data on debit and credit cards, points to weaker spending beyond Statistics Canada’s July reading.
Scotiabank analysts weigh in on how economic indicators and trends are influencing consumer prices, currencies and retail spending.
- That U.S. core inflation soared is becoming an all-too-familiar observation, yet it did it again in September by landing higher than consensus and a touch higher than my above-consensus estimate. There is nothing here that says core inflation and its breadth is softening or leaning toward a pivot by the Federal Reserve.
- The core consumer price index (CPI) was up 7% month-over-month at a seasonally adjusted and annualized rate (0.5% m/m SA non-annualized). The trend remains very hot and has been hot since April 2021 with a few soft patches along the way. On a year-over-year basis, 91% of the CPI basket is up more than 2%, 81% is up more than 3%, 72% more than 4% and 63% more than 5%. There are extremely widespread price pressures in the U.S. economy and there isn’t any evidence that the breadth of the pressures is cooling.
- Markets reacted by pushing the two-year Treasury yield up about 20 basis points (bps), the USD about 0.5% firmer on a Forex U.S. dollar index (DXY) basis and the S&P 500 about 1% lower so far. Fed funds futures are pricing in more than a 75 bps hike on Nov. 2, a 4.5% upper limit by December and a terminal rate at 5% in the first quarter of 2023, which I think generally makes sense with information at hand to date. In other words, about another 1.75 percentage points of rate hikes are pricing by Q1 from 3.25% now. I think the Federal Open Market Committee (FOMC) would be open to this path. The rate path has been pushed into uncharted waters with the Fed likely more determined to crush inflation’s back with whatever pain is necessary.
- In a sampling across components, food prices, both at home and away from home were up 0.8% m/m. Gasoline prices fell by -4.9% m/m as expected. Owners equivalent rent was up by 0.8% m/m and won’t turn for a while longer and only after a string of declines in repeat sale home prices. Used vehicle prices were down 1.1% m/m in line with expectations but surprisingly new vehicles were up 0.7% m/m. Across pandemic affected categories, vehicle rentals were up by 2.5% m/m, airfare was up 0.8% m/m, and lodging was down 1%. We are seeing disinflation in clothing categories as retailers switch between seasons. Apparel was down 0.3% m/m and soft for the past three months, with men’s wear leading the declines. Same with footwear.
— Derek Holt, Vice-President and Head of Capital Markets Economics
- The U.S. dollar continues to look quite fully valued from a fundamental point of view; markets are pricing in the Federal Reserve’s target rate reaching 4.6% by the middle of next year, in line with the latest FOMC projections. While we think the USD rally looks stretched, there is little or no sign it is ready to relinquish broader gains to any significant degree. The USD tends to strengthen on the back of positive economic news that lifts interest rates and depresses equity markets. It also gains when equity markets soften due to a spike in risk aversion (around heightened geo-political tensions or disappointing earnings news, for example). With stocks sliding to new cycle lows this week, falling some 25% from the early year high, demand for the currency remains strong.
- The strengthening USD has prompted central banks to push back on their own currency’s weakness. Intervention recently in Chile has been followed up by USD selling by the Bank of Japan as the yen slid to its lowest level since the late 1990s. The People’s Bank of China appears to be trying to stabilize the soft renminbi ahead of the Communist Party’s congress this month. Data suggests that global central banks have been selling their holdings of U.S. Treasury bonds and holding more USD cash reserves in preparation for intervention. Policy-makers in Canada and in Europe have noted that weak domestic currencies are hampering their own fight against inflation (as import costs rise). U.S. Treasury Secretary Janet Yellen said this week that the strong dollar was a “logical conclusion” of U.S. wider interest rate differentials, however, while suggesting the U.S. administration is not especially concerned by the USD and is highly unlikely to take action to curb strength at this point.
- The Canadian dollar has struggled against the tide of broader USD strength. Firm oil prices and a hawkish Bank of Canada are keeping the CAD trading at relatively firm levels against other G10 currencies, but USDCAD gains have extended to the mid-1.38s through late September and early October. The CAD continues to correlate closely with the broader risk environment. By our measure, the positive correlation between the CAD and the S&P 500 recently has never been tighter, certainly in recent market history. Our rolling one-month correlation study of daily returns shows a positive correlation between the CAD and U.S. equities of +83% currently; the correlation recently peaked at +92%. Seasonal trends suggest the fourth quarter is typically positive for stocks following the usual mid-year “wobble” in markets; firmer stocks may yet lift the CAD but the backdrop of rising rates and geo-political tensions rather point to risk assets remaining relatively soft in the next few weeks — meaning the CAD is at risk of more weakness.
— Shaun Osborne, Managing Director, Chief FX Strategist
- Our Canadian spending tracker continues to decelerate in September. While Statistics Canada’s latest retail sales report is only for July, our Canadian spending tracker hints at further weakness since then. As illustrated in the chart, our tracker recorded monthly declines in July, August and September, and it provides a decent correlation with retail sales. Our spending tracker is based on Scotiabank’s daily spending data on debit and credit cards, which gives a live pulse on spending. While the near record low unemployment rate (5.2%) and strong wage growth (5.2%) have until now supported spending, we have started to see weakness in the job market. The labour shortage narrative continues to grab a lot of airtime in the media, but the economy shed over 90,000 jobs in the past four months.
- We believe spiking interest rates also will take a toll on spending in the coming months and quarters as monetary policy acts with a lag. For instance, 5-yr fixed mortgage rates are around 5% and interest rates on 2023 car models are near or exceeding 6% at some dealers. Worse, Bank of Canada governor Tiff Macklem indicated in a speech last week that “there is more to be done” on the monetary policy front. The BoC has increased its benchmark by 300 basis points (bps)this year to 3.25%, and it could push them over 4% by year-end according to OIS (overnight index swaps). With spending being the main engine of the economy, the Canadian economic pulse should continue to face headwinds.
— Hugo Ste-Marie, Director, Portfolio & Quantitative Strategy; Jean-Michel Gauthier, Associate Director, Portfolio & Quantitative Strategy
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