Economic Inversion

The last month of Q1 was very volatile for the U.S. market as the S&P 500 started the month of March around the 4,300 level and quickly dropped below 4,200 by mid-month. The slide in the broader U.S. index represented a -14% return (Jan 1st – March 14th), but investors were quick to buy stocks at such low levels sparking a dramatic turnaround. Although, after a valiant 357-point stretch to finish the month at 4,530.41, it wasn’t enough to pull the major index back into positive territory as the S&P 500 finished the quarter with a -5.20% return on a year-to-date basis. While the U.S. market completed the first quarter of 2022 on a negative note, the renewed buying pressure exhibited mid-March is a healthy sign that investors are ready and willing to act if equities continue to demonstrate resilience in the face of such pervasive inflationary headwinds.  In Canada, we a see a completely different picture as the TSX appreciated nicely during the month of March, posting a +4.2% return to end the quarter on a positive +4.0% return year-to-date.
 
The economic data for March provided a heavy inflationary tone, with Europe jumping to 7.5% y/y and Spain posting the worst figure of 9.8%. Inflation is now higher than the unemployment rate for the first time in decades (Euro area unemployment was 6.8% in February). In the U.S. the jobless rate was 3.6% compared with 7.9% headline CPI inflation. U.S. inflation moved above the unemployment rate last August for the first time since 1990, and the gap looks set to get even wider. March CPI is expected to be above 8% in the coming release. Canada too is facing this economic inversion, where in February the unemployment rate tumbled to 50-year lows of just 5.5%, while the inflation rate surged to a 30-year high of 5.7%, which marks the first time since June 1982 that the Canadian inflation rate was higher than the unemployment rate.  
 
With a string of hawkish comments last week, the BMO Economics team bumped up both their Fed and BoC calls to hike rates by 50 bps at each of the next two decisions. They also call for the Fed to hike a total of 200 bps in the next six meetings and then another 50 bps in 2023 to 2.88% (50 bps higher than previous estimates). In both cases, policy will get to the low end of neutral quickly, and then eventually move above the mid-point of neutral – a necessary step to douse inflation. At this point there is no clear evidence that ‘growth’ is over and while we believe corporate earnings will continue to be positive, stagflation is becoming a more pressing concern that could prove more difficult to overcome.

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