FLCA - Will Higher Inflation Push The Bank Of Canada To Hike Rates Again?

2023-08-16 23:26:00 ET

Summary

• Headline inflation number was 0.6% month-over-month in July.
• Core inflation was at around 3.5% to 3.7%.
• There's not a lot priced in for September, but maybe a bit of a coin toss of whether they hike in October.

Canadian consumer prices ticked higher in July, but will it lead the Bank of Canada to hike rates in September? Moneytalk’s Greg Bonnell discusses with Hafiz Noordin, Portfolio Manager, Active Fixed Income at TD Asset Management.

Greg Bonnell: Canadian headline inflation reaccelerated in July. But will that lead to a Bank of Canada rate hike in September? Joining us now to discuss, Hafiz Noordin, portfolio manager for Active Fixed Income at TD Asset Management. Hafiz, great to have you back on the program, particularly on a day like this.

Hafiz Noordin: For sure.

Greg Bonnell: So let's talk about that headline number. I mean, we were expecting a reacceleration from June, when we got down below 3%-- a little hotter than expected. As we go beneath that headline number, what are you seeing that's interesting?

Hafiz Noordin: Yeah, I mean, the headline number was certainly a bit of a surprise. It was 0.6% month-over-month in July. The market was expecting 0.3%. And so that took the year-over-year inflation number to 3.3% on an annual basis. Market was expecting about 3%.

So yeah, a bit of a headline beat to the upside. But when you look at the core level of inflation, still running at around the sort of 3.5% to 3.7% range. That's basically in line with where it's been over the last few months.

So it didn't really change the narrative a whole lot, in terms of inflation having come down from those really high 5% core inflation rates that we saw late last year. We're meaningfully below that. But we're still well above the 2% inflation target.

Greg Bonnell: Now, we had been warned by the Bank of Canada that the last mile was going to be the hardest mile, that they thought we were going to stay around 3% for quite some time. When you get a print like this just a couple of weeks ahead of the next Bank of Canada rate decision -- I know they have a few other data points that'll come before then, but what do you think they might make of it? Do they think another rate hike is in the offing?

Hafiz Noordin: You know, you have to put it into perspective with what the broader economy has been doing. And so when you look at other data, other than inflation -- you look at growth metrics, you look at the labor market-- it's been a little bit more choppy. The labor market in particular, lots of beats to the jobs numbers earlier in the year. I'd say over the last few months, it's been some beats, some misses.

Even on the inflation data, this is one of the beats of the year. There's been two beats on inflation, but also three misses to the downside this year when you look at those monthly inflation prints. So, it's been kind of choppy. I think at the end of the day, for September, the September Bank of Canada meeting, the main data we're going to get before then really just looking at retail sales data. So that probably will show that consumption is still strong. We're not getting the next jobs data until after the September Bank of Canada meeting.

So there's not necessarily a whole lot that can really move them towards acting on this one inflation data print. They probably will want to see a little bit more data coming in September and October. So it's the October meeting where, perhaps, there's been going to be a little more of a chance that -- do they move or not? I think that's where the market's also leaning -- not a lot priced in for September, but maybe a bit of a coin toss of whether they hike in October.

Greg Bonnell: Let's talk about the market reaction, how they sort of responded to this. I think that was-- you used the word "choppy" before in terms of the data. Was the reaction of the choppy off of that hotter print this morning?

Hafiz Noordin: Pretty much. Yeah, you saw this knee-jerk reaction on, oh, there was a headline beat. And suddenly, bond yields were up eight to nine basis points across the curve. But as other data started to come in, we saw a bit of a weaker Empire Manufacturing data in the US and in home-building sentiment. So that helped to calm down both US and Canadian rates back to almost a little bit unchanged for the day.

And I think that's also even consistent with what we just talked about for the inflation data in Canada, where, yes, it was a headline beat. But the core inflation trend, still pretty much intact with what we've seen over the last few months.

Greg Bonnell: You talked about the October meeting perhaps being the one that's a little more live to some sort of a rate hike if the Bank of Canada does feel that all the information they'll get before that meeting warrants it. One question I get when I talk with people, sometimes outside of the bank, some media stuff that we do -- what about these cuts? What about these cuts? They want to hear about cuts. Is that even a 2024 story anymore?

Hafiz Noordin: It's still potentially a second half of the 2024. For Canada, when you look at where the market's priced in, this 5% policy rate is expected to stay there until next summer. And then it's after that that maybe there's the potential for rate cuts, really because inflation, by then, hopefully should have come down closer to target -- not at target yet, but really more convincingly on the way there.

And so that would allow the Bank of Canada to start to modestly reduce the policy rate to still be in the restrictive territory, but not at the same level it is now. For the US, though, I think that's going to be the interesting one to watch where it's broadly the same trend in terms of gradually declining inflation but a very strong labor market and strong growth. And unlike Canada, the market has priced in for the Fed to start cutting a little bit before next summer.

So I think that's going to be an interesting comparison to make between, how does the Fed move versus the Bank of Canada. Broadly speaking, they tend to move together. But the market's pricing a bit of this divergence that perhaps the Bank of Canada is on hold for a little bit longer.

Greg Bonnell: Now, when it comes to the United States, when I was saying off the top -- when we were taking a look at the markets, of course, they got retail sales numbers. They did come in stronger than expected. What I found interesting when I started reading through was sort of, like, the post-COVID life that we're living, right? You're out in restaurants. You're out in bars. You're having experiences. Maybe you need some clothes that aren't track pants to have some of those experiences and not look like a slob.

So, even though the top line number was stronger than expected, what would the Fed make of all that? I mean, the consumer seems to be holding in. But they don't seem to be buying big-ticket items.

Hafiz Noordin: Yeah, so I think the services part of the economy is still holding in pretty well, to your point. But it's the goods part of the economy, the buying stuff, is just not as needed as it was during the COVID days. So that's where we're seeing, even in the inflation data as well, that goods and core goods, inflation has really come down to basically flat now, both in Canada and the US. And it's the services part of the economy that's still very strong and very much linked to the tightness of the labor market.

So I think for central banks, there's probably not enough quite yet to say that they have to do another round of rate hikes beyond where they are now, 5% and 5.5% in the US. But I think it's maybe more of a decision around how long they hold at this really high level of policy rates. And I think that's where we have to just keep watching the data and see, are there cracks in the labor market or not? And we know that they intentionally need to try to get unemployment a little bit higher to bring more balance in the economy and get inflation back to target.

Greg Bonnell: Is sort of the fight against this taking longer than expected the reason why we've seen interest rates moving up in recent weeks? I mean, we started the year with a certain assumption. Rates started to fall a little bit. But they've been pushing higher lately. What's going on there?

Hafiz Noordin: Well, there's certainly been more growth surprises. So yes, the economy is holding up well even in the face of higher interest rates. We do know it takes a while, though, for interest rates to actually feed their way through the economy, make their way into higher borrowing costs based on when people are refinancing, whether it's their mortgage or other types of loans, or when corporates are refinancing their loans. So that process takes a while to actually increase everybody's interest expenses.

So I think -- but in the meantime, we have seen growth higher than expected, particularly in the US, where we're seeing near- or even above-trend growth in Q2 and Q3. So, I think that's been part of it. But there have been other factors as well. We've seen the Bank of Japan also reducing the amount of yield curve control they're going to have. They're allowing 10-year yields to be in a bit of a wider range. When you see that happen, that causes global rates across the globe to go a little higher.

And we're also seeing a little bit more of US Treasury issuance out of the government needing to issue a little bit more in the longer end of the curve. And so there's a number of factors that are coming into play to cause bond yields to go higher. But that's really causing what we call real yields, so nominal yields, less inflation expectations to go up. There isn't really a higher impulse in yields from higher inflation expectations. So the inflation story is still intact.

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