by BeiChin Lin, Russell Investments
On the latest edition of Market Week in Review, Investment Strategy Analyst BeiChen Lin and Client CIO Chris Kyle discussed key drivers behind the recent volatility in markets. They also chatted about the latest rate hikes from global central banks and assessed recent trends in the Canadian housing market.
U.S. November retail sales decline by more than expected
Kyle opened the conversation by noting that U.S. markets hit a rough patch on Dec. 15, with the benchmark S&P 500® Index skidding by roughly 2.5% over fears of a potential recession. Lin said the catalyst for the selloff was the release of U.S. retail sales numbers from November, which came in fairly weak. “Economists were expecting a 0.3% month-over-month drop, but instead, retail sales fell by 0.6%,” Lin stated, characterizing the decline as pretty substantial. In addition, newly released manufacturing surveys from New York and Philadelphia also pointed to contractionary conditions, he noted.
Altogether, these reports suggest that a slowdown in the U.S. economy is underway, Lin said, noting that this is to be expected due to continued rate increases from the U.S. Federal Reserve (Fed). “As the central bank continues hiking borrowing costs to more and more restrictive levels, the economy is going to naturally cool off,” he remarked. However, the cooling has not been uniform, Lin stated, explaining that the U.S. labor market remains robust. Case-in-point: The latest weekly jobless claims number fell by 20,000 from the prior week, he said.
“It’s important to remember that the labor market is a bit of a lagging indicator—and eventually, the lagging indicators are going to catch up to the leading indicators. Ultimately, I believe that the U.S. will likely experience a mild recession within the next 12 months,” Lin stated. Fears of such a recession are clearly causing some anxiety in markets, Lin added, noting that Russell Investments’ composite contrarian indicator—which measures investor sentiment—remains elevated, at +1.6 standard deviations as of Dec. 15. This shows that there’s a notable amount of pessimism in the marketplace, he said, as evidenced by the Dec. 15 selloff.
Fed, ECB and BoE all lift rates by 0.50%
Switching to central banks, Lin said that the Fed, European Central Bank (ECB) and Bank of England (BoE) all raised interest rates by 50 basis points (bps) the week of Dec. 12. In the Fed’s case, the latest rate increase was the smallest since May, ending a stretch of four straight jumbo-sized 75-bps rate increases, he stated. However, in a press conference following the rate hike, Fed Chair Jerome Powell noted that although some progress has been made in corralling inflation, more work remains to be done, suggesting that additional rate increases are likely in early 2023, Lin said.
In Europe, the ECB pushed back against the idea that its 50-bps rate hike signaled a pivot in monetary policy, he remarked, with ECB President Christine Lagarde saying that the central bank has more ground to cover than the Fed when it comes to additional rate increases. “This isn’t too surprising, as Europe has been hit with even higher rates of inflation than the U.S.,” Lin remarked.
He said that in the UK, the BoE also opted for a 50-bps increase in its policy rate, but that the vote among members of its rate-setting committee was a bit interesting. Six members on the committee voted to increase rates by 50 bps, while two members favored holding rates steady at 3% and another member voted for a 75-bps hike, Lin explained.
“At the end of the day, the situation in the UK is very complicated and poses quite a challenge for the BoE. On the one hand, the central bank is trying to bring inflation under control by lifting borrowing costs—but on the other hand, the country is either already in a recession or will be very soon, due in large part to the European energy crisis,” he stated.
Canadian home prices tumble
Lin and Kyle concluded the segment with a look at the Canadian housing market, which Lin said has softened notably in recent months. Newly published figures from the Canadian Real Estate Association show that home prices in Canada are down 11% from their peak in February, and that the volume of sales transactions has plunged by roughly 40% on a year-over-year basis, he noted. Lin explained that Canada tends to be more sensitive to rate hikes than the U.S., due to differences in its mortgage structure.
Amid the softening, Canada’s banking regulator, OFSI (the Office of the Superintendent of Financial Institutions), recently announced an increase in its minimum domestic stability buffer—a key component of the minimum capital requirements—for banks, he said. This change, taking effect Feb. 1, 2023, should ensure that lenders have a little more of a cushion in place in the event of a further economic downturn, Lin explained.
In addition, on Dec. 15, OFSI announced it would be leaving in place its minimum qualifying rate requirement for uninsured mortgage borrowers, he said. “This requirement acts as a bit of a stress test for borrowers, as it helps ensure they’ll still have the ability to pay off their mortgages if rates rise further,” he explained.
Ultimately, Lin said that while he expects more softening in housing markets across many developed markets, including Canada and the U.S., a repeat of the 2008 housing-market collapse appears unlikely, due in part to the role banking regulators are playing in today’s environment.
Editor’s note: After a break for the holidays, Market Week in Review will return on Friday, Jan. 6.
