Michael Watkins
June 02, 2023
Weekly Market Update
With the debt ceiling drama behind us, markets are reacting with positive momentum to end the week.
In the first quarter of 2023, Canada’s economy posted its fastest pace of annualized growth since the second quarter of 2022. Canadian consumers were the key drivers of growth over the quarter, showing their relative resilience despite facing immensely tight financial conditions. With economic growth on pace to exceed the Bank of Canada’s (BoC) outlook, market participants contemplated if it, along with persistently elevated inflation, could lead to more rate hikes.
- Canada’s gross domestic product (GDP) expanded by 3.1%, annualized, in the first quarter of 2023. The increase marked a relatively strong rebound from the revised 0.1% decline in the fourth quarter of 2022.
- The growth rate came in above the 2.5% increase economists expected, according to a Bloomberg survey of economists.
- Household consumption was a key driver of growth over the quarter. Despite tight financial conditions, spending remains relatively robust largely due to a strong labour market. A rise in net exports also contributed to growth.
- There were, however, some pockets of weakness in Canada’s GDP. Real estate investment continued to contract, hindered by higher mortgage rates, which weighed on demand. Business investment also pulled back as businesses grappled with higher interest rates.
What is next for the BoC? With growth exceeding its outlook and inflation remaining high, the BoC could return to monetary policy tightening.
In this second quarter of 2023, pressures are easing for Canadian businesses. Still, according to Statistics Canada’s (StatsCan) Canadian Survey on Business Conditions, the outlook for the next three months might include several obstacles that could weigh on business activity. The potential obstacles aren’t surprising, given the level of uncertainty in Canada’s economic outlook and the persistence of tighter financial conditions, geopolitical tensions and financial market volatility.
- The StatsCan survey found that almost 50% of businesses believe their operating costs will increase over the next three months, with about 30% believing profits will drop. This could limit companies’ ability to reinvest in their businesses, particularly in labour and other capital expenditures.
- One of the largest obstacles facing Canadian businesses is high inflation. While Canada’s rate of inflation has eased in recent months, it remains at relatively elevated levels. About 56% of businesses cited inflation as the greatest obstacle over the next three months. Second on the list are rising costs of inputs, including labour, capital and raw materials.
- Conversely, fewer businesses expect supply chain challenges over the next three months. Amid the pandemic, supply chain disruptions posed massive challenges for businesses and contributed to surging prices for many goods and services.
- Many believe the outlook is relatively bright. Just under 75% of businesses are very or somewhat optimistic about their outlook, higher than the previous quarter. Optimism was particularly high in the finance and insurance industry.
Business conditions appear to be less than ideal, but the perception of the future is beginning to appear brighter. With a stronger outlook, businesses might be more inclined to invest in capital and labour, which are vital for a healthy Canadian economy.
Looking at the bigger picture, a key indicator of global economic health has been challenged this year. For much of 2023, manufacturing sector activity across many major economies continued to contract, hindered by weak demand and falling output. Data released yesterday shows it’s the same story for May.
- In Canada, manufacturing sector activity contracted for the second time in the last three months. The S&P Global Manufacturing Purchasing Managers Index (PMI) revealed a drop in new orders and output dragged Canada’s manufacturing sector down.
- In May, the US manufacturing sector posted its sharpest contraction since February 2023. The manufacturing sector is such a key component of the US economy that soft results reverberate worldwide.
- Europe’s manufacturing sector continues to struggle in 2023. This was particularly evident in Germany, Europe’s largest economy. Germany depends heavily on its manufacturing capabilities but shrank over the last 11 months. The decline pushed the German economy into a technical recession in the first quarter.
- Conversely, the Caixin China Manufacturing PMI revealed China’s manufacturing sector expanded in May, albeit at an ultra-slow pace. New orders and output grew over the month.
Manufacturing is a key indicator to watch as you assess global economic health. Recently, however, weak manufacturing activity has weighed on global economic growth, adding to investor uncertainty. As this mixed data was released this week, the price of oil, one of the key inputs in manufacturing, swung between gains and losses. Exposure to oil and other commodities is important for your portfolio, but keep in mind commodity prices may be volatile, given their sensitivity to changes in economic conditions.
As always, please give us a call if you have any questions, or if you’d like to get together for a portfolio review.
Source: CIBC Morning Market Brief