CPI data-just how Fed-friendly was it?
Michelle began the conversation on the topic of CPI data. Shay noted that “we can all… breathe a sigh of relief, as the June inflation did come in the direction that I think we can interpret as Fed-friendly, which in turn made a very market-friendly data point as well.” Shay noted that, since the CPI release, “equities have been on an upward trajectory. Yields have been lower, which in turn means that bond prices have been up. So markets have been behaving quite nicely since the release.”
So what’s all the hype about? Shay noted that inflation numbers were below the consensus. But not only that, they did take a nice step down from where they were in prior months. “If you start with headline inflation-headline inflation rose 3% on a year-over-year basis. And that’s down from 4% in May, while core inflation increased 4.8%, and that’s down from 5.3% in May.”
Shay pointed to another key component- shelter inflation-calling that measurement out particularly sticky. Shay said: “We know that’s been sort of a lagging indicator because rental growth-in terms of some of the more real-time indicators of rental growth-has been decelerating. So shelter inflation this month actually did also take a notable step down on a month-over-month basis, which is welcome news.”
The last rate hike?
The most interesting news, according to Shay? “Core inflation rose just 0.16% on a month-over-month basis. “Now, what’s the importance of 0.16? Well, a couple things. One is that level of sequential monthly appreciation is the lowest level we’ve seen in quite a while. But more importantly, if you annualise that number, what you get is roughly 2% on an annualised rate. Obviously, 2% we know at the core inflation-that’s the Fed’s target. And we clearly don’t want to extrapolate too much from just one print. But I think the takeaway is that progress is clearly being made in the fight against inflation.”
Shay acknowledged that “we are not completely out of the woods just yet,” as the labor market is still pretty tight. This week, the Atlanta Fed’s wage tracker release marked wage growth as still hovering between 5.5 to 6%.
What’s this mean for future Fed rate hikes? Shay noted that the July meeting is only a couple of weeks away “and the markets have about a 90% probability to a rate hike. It would be pretty out of character, quite frankly, if the Fed did not deliver on a hike when the markets have such a high probability to one, so we do believe a hike in a couple weeks is fairly likely.” Shay stated that, from that point forward, a lot will depend on inflation dynamics, economic activity, and moderating employment growth. He concluded that “if things continue to moderate in terms of the broader economic outlook, we do think the July hike could be the last one for this cycle.”
Bank of Canada hikes rates. What’s next?
Michelle switched the topic to the Bank of Canada (BOC), pointing out that the bank had another rate hike. Michelle asked Shay to talk through the reasoning and the expectations around future BOC policy.
Shay noted that the BOC surprised markets in June with a 25-basis-point rate increase. In contrast, this month, the Bank of Canada once again hiked rates by 25 basis points and raised their target rate to 5%, “but this move was pretty much as expected, said Shay. “The markets had priced in about a 70% probability of a rate hike, so there was really not much of a surprise there. It was pretty much inline.”
Shay noted that the BOC’s reasons for the hike were that growth and inflation are continuing to progress much stronger than the Bank of Canada had expected, relative to their April forecast. And the bank continues to believe that the Canadian economy continues to operate in excess demand. Shay stated: “As a result of that stronger demand and stronger inflation, they do believe that growth for 2023 will be much stronger than they perceived it to be back in April.”
There are some encouraging signs that the Bank of Canada did want to flag. One was that inflation has seen quite an advancement in getting towards the target. The headline inflation peaked at 8.1%. It’s currently at 3.4% as of May.
The BOC believes that getting to their 2% target is going to take longer than the bank had previously expected or communicated. They don’t believe the 2% target will be reached until mid-2025. Shay noted that BOC Governor Tiff Macklem did make some interesting comments at the press conference. Macklin pointed out that the committee debated whether the bank should have kept the target rate unchanged at this meeting. Shay said: “That suggests that the bank is acutely aware of the risks of overtightening into an economy with heavily indebted household balance sheets. So there is clearly a concern that the Bank of Canada is very much aware of.” Shay pointed out that the revised policy rate is now at 5%-effectively double the midpoint of the 2-3% neutral rate that the Bank of Canada estimates. So unless we see further surprises to the upside in terms of inflation, employment, and growth,” said Shay, “we believe that the next move for the Bank of Canada might be to get back toward a pause in its policy.”