Michael Watkins
January 05, 2024
Weekly Market Update
Happy New Year! I hope everyone enjoyed the holidays! The year ended with a strong rally over the last two months, putting the markets nicely in the black for the year. Much of this turnaround can be attributed to shrinking inflation, and the increased expectation of rate cuts as we move into 2024.
S&P Global reported that business activity in Canada contracted for a seventh consecutive month in December, reinforcing signs of a slowdown in the Canadian economy. High borrowing costs and persistent inflationary pressures are weighing on consumer and business activity, hindering Canada’s economic growth. The slowdown was widely expected after the Bank of Canada (BoC) undertook an aggressive rate increase campaign to lower decades-high inflation.
- The S&P Global Canada Composite Purchasing Managers Index slipped to 44.7 in December from 44.8 in November. (A reading below 50 denotes contraction.) The index reflects overall business activity in Canada through activity in its manufacturing and services sectors.
- Relatively muted demand weighed heavily on the index in December. New orders dropped to their lowest level since June 2020. Domestic and global consumers have been hindered by tight financial conditions, which have dragged down manufacturing and services sector activity around the world.
- The services sector contracted for a fifth straight month. Within the sector, new orders and output both dropped considerably. Despite December’s drop, services sector managers expressed optimism about the future, particularly as expectations rise that the BoC might start reducing interest rates, which might ease the pressure on Canadian households.
- Earlier this week, S&P Global announced Canada’s manufacturing sector shrank in December, also seeing a drop in new orders and output. Additionally, employment contracted at manufacturing firms over the month.
Canada’s economy has struggled for traction in recent quarters as tight financial conditions persist. The Canadian economy shrank in the third quarter with more recent data showing it stalling in the fourth quarter. Despite the downturn, economists are hopeful the economy might avoid a deep recession and can return to growth.
In other economic news, Canada’s manufacturing sector struggled in 2023, weighing on the overall health of the Canadian economy. Tight financial conditions, both domestically and abroad, have hindered activity in this critical economic sector. But Canada isn’t alone in this. Manufacturing across many major economies has been challenged by relatively muted demand and lower global trade activity.
- The S&P Global Canada Manufacturing Purchasing Managers Index fell to 45.4 in December, from 47.7 in November. (A reading below 50 signals contraction.) December’s reading was the lowest since 2020, highlighting the steep challenges being faced by this key sector of Canada’s economy.
- New orders fell at a relatively sharp pace in December, largely as a result of muted domestic and global demand amid tight financial conditions. The drop in new orders weighed on output over the month, with manufacturers scaling back production.
- Employment within the sector fell in response to the drop in output. Employment within the sector fell to its lowest level since 2020, suggesting some cooling in labour market conditions.
- The decline in manufacturing sector activity wasn’t isolated to Canada’s economy. US manufacturing activity shrank at its fastest pace since June 2023, while Europe’s manufacturing sector contracted for a 17th straight month.
Canada’s manufacturing sector has gone through downturns before, but its overall strength has helped it recover. Expectations of looser financial conditions might help raise demand, which might benefit the sector. Despite the downturn, Canada’s manufacturing sector remains relatively healthy and could benefit when economic conditions improve. In addition, industrials sector stocks, where many manufacturing firms reside, posted a strong gain over the year amid expectations of lower interest rates and strong growth prospects.
Looking to the South, the US Federal Reserve Board (Fed) released the minutes from its last meeting, which took place in December 2023. At that time, the Fed stated its expectations for the potential to begin reducing interest rates in 2024. While that might not be a foregone conclusion, inflation has come down substantially, and the Fed noted economic activity is expected to slow.
- The minutes showed Fed officials believe interest rates are restrictive and might need to be left at current levels to help bring inflation down further. As such, the federal funds rate might have reached peak levels.
- Fed officials acknowledged the US inflation rate has come down substantially. Should inflation keep dropping closer to its 2% target, the Fed might be inclined to start lowering interest rates. With that said, projections show Fed officials expect rate cuts by the end of 2024.
- The Fed held the target range of its federal funds rate steady at 5.25%–5.50% at its December meeting. The US central bank lowered its projection for inflation in 2024, while expecting economic growth to slow versus 2023.
- In signs of cooling in the US labour market, the US Bureau of Labor Statistics announced job openings dropped in December. Job openings were 8.79 million in December, the lowest number since March 2021.
While it might not be immediate, the Fed beginning to reduce interest rates later in 2024 appears to be a strong possibility. This action from the Fed could also nudge the Bank of Canada to start cutting interest rates as it sees slowing inflation and economic growth in Canada. In the meantime, financial markets could swing between gains and losses as investors try to predict the timing and depth of interest-rate cuts with each economic announcement.
As always, please give us a call if you have any questions, or if you would like to book a portfolio. Of course, with the start of the New Year comes an increase to everyone’s TFSA contribution room. This year the additional room has been boosted to $7,000 per person
Source: CIBC Morning Market Brief