Inflation rises in Canada. How could this impact the Bank of Canada’s upcoming decision on rates?

November 27, 2024

3 minute read

Executive summary:

Canadian inflation rates ticked up during October
U.S. Q3 earnings continue to look resilient
U.S. credit spreads recently hit multi-year lows

On the latest edition of Market Week in Review, Investment Strategist BeiChen Lin reviewed the latest inflation numbers from Canada. He also provided an update on U.S. third-quarter earnings season and discussed the recent tightening in U.S. credit spreads.

October CPI, PPI numbers inch up in Canada

Starting with Canada, Lin said there were two major datapoints released the week of Nov. 18 pertaining to inflation—the consumer price index (CPI) and the producer price index (PPI). On the CPI side, both the core and headline readings came in hotter than expected, he remarked.

“The headline CPI increased to 2.0% in October on a year-over-year basis—slightly above consensus expectations for a 1.9% gain. In addition, two measures of core inflation—CPI-trim and CPI-median—also exceeded analysts’ expectations, rising 2.6% and 2.5%, respectively,” Lin stated.

All told, this pushed the average of the Bank of Canada’s (BoC) three preferred measures of core inflation to 2.4% year-over-year in October—up from 2.3% in September and 2.2% in August, he noted. Lin stressed that while inflation in Canada is still far below its 2022 peak, the numbers from the last few months have been a bit disappointing.

“Because of this, investors are carefully monitoring the situation to see if the recent uptick in inflation is a temporary setback—or a more worrisome trend for the BoC,” he remarked, adding that the October PPI numbers also came in stronger than anticipated.

As a result of both the CPI and PPI reports, Lin said market participants have reduced their expectations for the size of a December rate cut from the BoC. “Markets are now leaning heavily toward only a 25-basis-point (bps) cut instead of a 50-bps cut,” he remarked. However, Lin said the Russell Investments strategist team’s perspective is more open-minded, noting that the BoC will have a few more important data points to weigh—including third-quarter GDP (gross domestic product) and the October jobs report—before making a decision on rates.

U.S. Q3 earnings season update

Turning to U.S. third-quarter earnings season, Lin said that overall, corporate earnings continue to look resilient. S&P 500 headline earnings growth is around 10% so far, he said, although if the Magnificent Seven companies are excluded, that number drops to around 6%.

Lin noted that two large consumer companies reported the week of Nov. 18, with differing results—one with stronger earnings and forward guidance, and one with weaker earnings and forward guidance. The results from both were of significance, Lin said, because the consumer sector tends to be an important watchpoint for the health of the nation’s economy. “Simply put, consumer spending is a powerful driver of U.S. economic activity—contributing to roughly 70% of annual U.S. GDP,” he remarked.

Lin stressed that Russell Investments’ base-case scenario for 2025 remains a soft landing—where the U.S. economy slows but does not tip into a recession. However, in order for such an outcome to be achieved, consumer spending needs to remain resilient, he stated.

What’s behind the tightening in U.S. credit spreads?

Lin finished with a look at U.S. credit spreads, which he said are important because they measure the potential incremental return investors can get from investing in corporate debt over government bonds.

He noted that lately, spreads have compressed to some of the narrowest levels in recent history. As evidence, he pointed to the spread for U.S. high yield bonds, which has compressed to under 300 bps (basis points) over U.S. Treasurys.

So, why the tightening? Lin said it’s probably partly due to companies generally being in good financial health and partly due to the market pricing in a lower probability of corporations defaulting on their debt.

“From our perspective at Russell Investments, however, we’re a bit more cautious here. We think recession risks are still somewhat above average—and because of this, we think there’s a chance that these spreads could widen out a bit in 2025. However, we’re not seeing enough of an unsustainable extreme to want to tactically underweight credit just yet,” Lin remarked. He concluded by noting that during times of uncertainty like today, investors are probably better served by staying disciplined and continuing to monitor the latest data in the corporate credit market.