Michael Watkins
June 09, 2023
Weekly Market Update
In an unexpected move, the Bank of Canada (BoC) returned to hiking its key interest rate, with inflation running at elevated levels and Canada’s economy remaining relatively robust. While a Bloomberg survey indicated economists did not expect the move at this meeting, many anticipated more rate increases from Canada’s central bank after Canada’s economy posted stronger-than-expected growth in the first quarter.
- The BoC raised its benchmark overnight interest rate by 25 basis points to 4.75%, the highest level since 2001. The increase followed two consecutive rate holds as the BoC expected inflation and Canada’s economy to moderate.
- Excess demand continues to drive high inflation and economic growth. Despite tighter financial conditions, demand remained strong and outstripped supply, helping to keep prices elevated.
- The potential for inflation to remain sticky at levels well above the BoC’s 2% target concerned officials. The BoC believes this rate increase was warranted to help bring supply and demand back into balance, which could drive inflation down and slow an overheated economy.
- What comes next from the BoC is unknown. The BoC provided little direction on whether it has returned to its rate-hike path. It did note it would carefully monitor the impact of tighter monetary policy on Canada’s economy as it makes upcoming interest rate decisions
Canada’s central bank reiterated its commitment to restoring price stability in Canada, which could result in more rate hikes. Rate increases will likely lift bond yields, put pressure on bond prices, and create volatility in equity markets
In other economic news, the Ivey Purchasing Managers Index (PMI) released this week showed Canada’s business activity expanded in May but slower than the previous month. Canada’s economy posted stronger-than-expected growth in the first quarter of 2023. The PMI reading revealed Canada’s economic activity continued to grow in the second quarter despite considerable headwinds
- The Ivey PMI fell to a reading of 53.5 in May from 56.8 in April. Despite the slowdown, business activity remains expansionary, suggesting Canada’s economy is resilient despite tight financial conditions and weakening economic conditions worldwide.
- May’s result marked the second consecutive slowdown, largely due to easing employment growth and rising inventories.
- The reading above 50 showed that May’s purchases were higher than the previous month, indicating positive business activity. Canada’s economy expanded by 3.1%, annualized, in the first quarter of 2023, and growth may continue in the second quarter, albeit at a relatively slower pace, according to the Ivey PMI.
With regard to crude prices, Saudi Arabia plans to reduce its oil production by one million barrels of oil per day beginning in July. The Organization of the Petroleum Exporting Countries (OPEC+) held its June meeting this past weekend. Oil prices fell sharply over May, precipitating Saudi Arabia’s actions to stabilize oil prices amid uncertain economic conditions.
- Saudi Arabia will reduce oil production by 1 million barrels of oil per day in July. This would bring oil production in the country to a multi-year low of approximately 9 million barrels per day. This additional reduction will last for one month but can be extended.
- OPEC+ held its June meeting over the weekend. OPEC+ announced it would limit oil production to 40 million barrels of oil per day over 2024. The oil cartel agreed to cut production further through 2023 to address oil price volatility. At its April 2023 meeting, some members agreed to voluntary production cuts to help stabilize prices.
- Oil prices have fallen in 2023. A key impact on oil prices has been uneven economic conditions, which have raised uncertainty about the global oil demand. This has been particularly acute in China, a main importer of OPEC-supplied oil. It has experienced challenging economic conditions this year.
The price of oil plays a key role in the health of Canada’s energy sector, which in turn is a fundamental component of Canada’s economy. Canadian energy company shares can be relatively volatile alongside the price of oil. Still, exposure to some high-quality energy companies in Canada provides access to a key sector of Canada’s economy and to stocks considered cyclical, which may outperform when economic conditions are stronger.
Over in the European Union, tighter financial conditions and slower global economic activity hindered Europe’s economy during the first quarter of 2023. After a downward revision to its fourth and first-quarter growth, Europe’s economy fell into a technical recession in the first quarter. The decline reveals the global economy’s relative weakness, which is creating considerable uncertainty among market participants
- A third and final estimate from Eurostat revealed Europe’s gross domestic product shrank by 0.1% in the first quarter of 2023. The decline was down from the 0.1% pace of growth in earlier estimates. A contraction in consumer spending drove the decline, as households appear to be struggling amid rising interest rates and elevated inflation.
- Eurostat also revised Europe’s 2022 fourth-quarter growth rate lower. Originally, Europe’s economy posted no growth (0.0%), but this was revised down to a 0.1% decline. With two straight quarterly declines, Europe’s economy entered a technical recession.
- The technical recession for Europe’s economy is unlikely to deter the European Central Bank (ECB) from remaining on its interest rate hiking path. The ECB is committed to bringing down inflation, which remains well above its target. Europe’s economy is expected to slow in response.
- Global economic growth has been uneven in recent quarters. Germany recently reported its economy fell into a technical recession, which is now the case for Europe. Economic activity in the U.S. and China has been relatively slow. Meanwhile, countries, including Canada and Japan, have seen stronger-than-expected growth in the first quarter
The slowdown in Europe is sure to spill over to other economies worldwide, including Canada’s. Yet, Canada’s economy posted robust growth despite weakening conditions elsewhere. With uneven global economic activity, tight financial conditions and persisting geopolitical tensions, financial markets may continue to be volatile. Europe’s economy can bounce back, which could give some tailwinds to European equities. While European equities have been volatile, there are some strong companies that may provide significant upside potential. Europe remains a quality place in which to invest.
As always, please give us a call if you have any questions, or if you’d like to schedule a portfolio review.
Source: CIBC Morning Market Brief