Hi everyone,

 

I was remis this week as I missed my Tuesday edition of “What’s Happening Today”. No excuses, just smokin’ busy (which I will never complain about). So there’s lots to talk about as we ease into the weekend.

 

Canadian inflation climbed even higher in August, but the point reached might represent the peak of the mountain. The surprisingly strong 0.2% gain in prices not seasonally adjusted took headline inflation all the way up to 4.1%, the highest print since 2003 and above consensus expectations for an annual rate of 3.9%. Some of the increase in the headline number just reflects base effects from a weak print a year ago falling out of the calculation. Moreover, unlike the US, which was already experiencing the headwinds caused by the Delta variant, Canada was still reopening in August. As a result, prices for a number of services that were made available again continued to increase and make up ground lost last year. Homeowners' replacement costs posted another strong reading despite weakness in other parts of the housing market this summer, offsetting a further drop in mortgage interest costs. Overall, with base effects continuing to fade and the fourth wave of the virus in Canada creating a headwind for services businesses, the annual rate of inflation will likely begin to fall in upcoming months. Furthermore, the core-common component measure of inflation was still only 1.8% in August. As a result, the Bank of Canada won't be overly concerned with even the above 4% headline print, since it doesn't seem like the sustainable inflation central bankers are looking for. Still, the surprise has pushed yields slightly higher and the Canadian dollar a touch stronger.

 

When surging energy prices become front page news you can bet that politicians as well as consumers will sit up and take notice. Expect some loose chatter of price caps as the politicians are keen to be seen to be doing something to support the consumer. In view of the Bloomberg energy sub-index having gained almost 25% in less than a month, the race to determine the winners and losers from the price rally is now becoming evident. For those industries and sectors who are highly energy intensive, margins are likely to be squeezed unless price gains can be passed down the price chain. While most large energy users will be hedged in the short term, the longer the price pressures persist the greater the risk of those hedges rolling off and the price gains having a more substantive impact. Sectors at risk include building materials, and this is a particularly notable sector amidst assumptions of substantive infrastructure investment plans in both the US and the EU.

 

Turning to the US. After the better than expected retail sales report and above expectations Empire and Philly Fed outcomes, today sees the release of provisional Michigan sentiment for September. After the August reading slumped to pandemic low of 70.3, amidst worries over the Delta variant, higher inflation and modest employment growth, we should witness a modest bounce. Early signs of a stalling in the advance in the Delta variant and a return to schools should encourage a modest beat of the 72.0 median. The last two Michigan sentiment releases have seen sentiment dip by more than 15 points. If the series can perhaps make back around a third of that decline in September this should keep the Dollar supported into Fed week. In view of the building inflationary narrative, energy price gains are integral to that view, we will monitor the inflation expectation criteria closely. One year inflation expectations registered a thirteen year high at 4.7% in July.

At the same time, President Biden continues to struggle to get Congressional Democrats on side with his own economic agenda. The President used a White House speech to remind members of his party that "For a long time, this economy's worked great for those at the very top." It seems as though the President is intent upon underlining income differentials and economic outcomes to encourage his own party to support his economic agenda. However, as a Senator Manchin failed to be persuaded to back Biden’s USD3.5trn spending bill in a face-to-face Oval office meeting it seems as though the President’s negotiating skills and diplomacy are failing him. This suggests the final package may be somewhat smaller than envisaged. Meanwhile Congressional Democrats are moving forward with a stopgap spending bill in an attempt to keep the government operating after October 1. There are some who suggest debt ceiling issues may preclude the Fed from tapering.

 

While markets are intent upon looking forward to the Fed, we now have the European Central Bank caught in something of a war of words with the Financial Times. Although the ECB agreed to throttle back on PEPP purchases at their recent gathering, many of the key decisions were thrown forward to December, notably when the ECB will have staff forecasts until 2024. However, the FT have reported that ECB Chief Economist Philip Lane told German economists, on a private call, that the ECB could hit the its elusive 2 per cent inflation target by 2025, according to unpublished internal models. As a consequence it could raise rates in just over two years, potentially up to a year ahead of that discounted by most in the market, including ourselves. The ECB are pushing back against the FT story suggesting that "Mr. Lane didn't say in any conversation with analysts that the euro area will reach 2% inflation soon after the end of the ECB's projection horizon." The ECB do expect to reach their 2% target threshold over time, albeit they have yet to specify a time horizon. The nature of the story throws up several issues, not least off the record briefings to selected analysts. The ECB were intent upon throwing forward the key decisions to December due to the fact that wish to use 2024 staff forecasts as a guide. Moreover, in view of the policy review the ECB have a number of criteria to fulfil prior to adjusting rates.

 

1. Firstly, the bank requires inflation to reach 2% well ahead of the end of the forecast horizon, that currently extends top 2023. According to Lagarde CPI needs to reach the threshold prior to the mid-point of the forecast profile.
2. Secondly, not only does the bank require CPI to reach the 2% target prior to the mid-point of the three year forecast horizon it is required to remain in line with the target throughout the projection period. That is a clear reference to past policy mistakes, namely reacting to price gains that were not durable.
3. Finally, although the ECB target headline inflation, (they are keen to incorporate living costs into the mix) the evolution of core prices is also seen as key to their policy mandate. As a consequence the bank stipulates the need for core prices to be at levels consistent with stable headline inflation around the 2% target threshold.

 

Meanwhile in the UK, the official ONS retail sales data the volume of goods sold in UK shops declined for a fourth month in August, this marks the worst run since 1996. Weakness was blamed upon the resurgence of the Delta variant and supply shortages. Ahead of the retail release we had seen UK rate expectations dragged forward, prior to the data some 11bp of tightening was priced for February. Post the data miss we have seen only a limited re-pricing, less than 1bp, this comes as the market continues to expect the Bank of England to become increasingly hawkish into 2022. The ONS data revealed across the board weakness in sales volumes. Not only did sales dip 0.9% in August, the July reading was revised down to a decline of 2.8%, this may further compromise the already disappointing 0.1% gain reported in July GDP. The impact of higher prices can also been seen in the retail sales deflator. Headline prices are now up 3.5% year-over-year. Consumers are facing higher prices and for now they appear, at least according to the ONS, to be balking at spending. The economy remains on course to retake lost post pandemic ground in Q4, underlining the prospect of a more hawkish BoE.

 

Finally, Asian markets closed mixed on a quieter day as concerns about China’s regulatory crackdown and slowing global growth weighed on risk sentiment. China formally applied to join Asian Pacific trade pact but reports noted acceptance is far from certain. U.S./China tensions remain as China extended tariff exemptions for 81 US products by seven months.

 

Jordan also posted a quick video on fees that can be found on our Facebook page!

 

As always, give us a shout if you have any questions, or just to have a chat.

 

Stay safe,

 

Mike, Mark, Jordan, Karen, and Kelly