After bouncing along for much of the year with markets seeing either only slightly up or slightly down months, November came on strong, with both stocks and bonds posting impressive gains. The catalyst? Continued moderation in US inflation numbers. The consumer price index for October, increased by less than anticipated, fueling expectations that further interest rate increases are not necessary. Over 16 months, the US Federal Reserve hiked rates at an unprecedented speed from 0.25% in March 2022 to 5.50% in July 2023. In Canada and the US, equity markets advanced with broad participation, while the Canadian Bond Universe Index was also up 4.29% for the month.
October ended up being another difficult month in the market, as interest rates continued to climb, with the US 10-year Treasury rate crossing the psychologically important 5% level. However, late in the month, markets rallied as 10-year rate started to decrease on hopes that we had reached a cyclical peak for interest rates.
Between another averted US Government shutdown and strikes across different industries, investors have had plenty of risks to consider recently. However, the main risk on investor’s mind has to do with interest rates. In fact, many traders have become fixated with US long-term interest rates – the cornerstone of all financial markets - which went above the psychologically important 4.5% level in September (for reference this was at 3.5% as early as May of this year) marking the highest level in over 15 years. This has great influence on fixed income markets as the price of bonds move inversely with direction of interest rates, and long-term bonds (i.e. 10+ years in maturity) are the most impacted. But not all is negative, weakness in September has created some value in stock pricing, although one needs to be selective.
In fixed income, the 10-year US Treasury yield has remained consistently above 4% in recent weeks with levels once again near 15-year highs. Given what is likely to be a higher for longer interest rate environment, yields are likely to remain elevated when compared to recent years for the foreseeable future, a scenario that continues to worry many investors as it relates to stock market performance.
Are we at the end of the line with interest rate increases? In July, both the Bank of Canada and the US Federal Reserve, were at it again, raising rates another quarter point. While many think that these latest increases were unnecessary given the already sharper lower inflation trends, there is a strong likelihood that each central bank now will pause to assess the impact of previous rate announcements. BMO Economics is forecasting that, data dependant of course, a September skip (i.e. no rate increase) will turn into a prolonged pause, “in other words, welcome to terminal territory”.
The interest rate environment continues to influence market discussions as early June saw another rate hike by the Bank of Canada. Meanwhile in the US, the Federal Reserve paused its tightening cycle, however, talk from Fed officials continue to indicate that at least one more further rate hike, if not two, are a possibility this year. Despite these hawkish signs, equities in Canada rallied in June, bringing the S&P/TSX 1-year return numbers back into the black.
As mentioned in last month’s commentary, the topic of the U.S. debt ceiling dominated market headlines in May. With uncertainty up to the end of the month, markets in both Canada and the U.S. lost ground during May. And although there was some back and forth with the negotiations, the deadline was ultimately met at the Senate vote in early June.
Political interest is intensifying regarding the U.S debt ceiling, and with it presents a risk to markets and may lead to increased volatility over the next few months. Still, if history is any guide, the US government will reach a deal sometime in the eleventh hour, avoiding an outcome where the Treasury won't have enough funds to pay its obligations. In order to get the votes required to raise the debt ceiling, Democrats are probably going to have to offer modest policy concessions to Republicans. The political pressure to reach a deal will be immense, so even if it goes past the deadline a deal is likely to be reached in time.
The banking sector got a scare in March after US regional, SVB Bank failed following a run on deposits. Elsewhere Swiss bank, Credit Suisse, was purchased at a deep discount by UBS Group due to concerns of its viability after plans to borrow funds to shore up its liquidity fell through. Thus far, the banking sector’s turmoil appears to be contained to the above-mentioned banks with specific issues, and two smaller crypto related banking institutions.
In February, indices gave back some of the gains achieved in January as markets grapple with several risks and concerns at this point of the cycle. Continued geopolitical tension with Russia and China, a debt ceiling showdown coming in the U.S. (although expectations are for some type of agreement – as always – since a U.S. default seems an unlikely outcome), economic and earnings deceleration, and higher-for-longer inflation and interest rates.
Equity markets got off to a good start for the year in January posting strong gains in both Canada and the US. Also joining the party were fixed income investments as both bonds and preferred shares saw positive performance for the month. Helping drive asset values higher in January was continued progress on the inflation front. In Canada, January’s report on CPI figures saw the annualized number fall month-over-month from 6.8% to 6.3%, while in the US there was a similar reduction (from 7.1% to 6.5%). Although inflation is still higher than central banks are targeting, levels have been consistently trending lower since peaking in summer.
The year 2022 was volatile and difficult to navigate with seemingly very few places to hide in either equities or fixed income investments. This created an understandable general feeling of anxiety and pervasive bearishness among investors. With that said, while we expect volatility to remain, economic momentum should pick up (from low levels) as we move through 2023. As we have noted in previous commentaries, securities markets are primarily influenced not by absolute numbers but by the trajectory of key macro variables. On that front, the situation is already improving for inflation – though it may be a slow trek to get back down to the Bank of Canada’s desired 1-3% range. As always, the stock and bond markets will discount and price in these improvements well before we see the evidence in the “real world”.