HIGHLIGHTS OF THE WEEK
United States
- Markets started the week off on a good note on French presidential election results and fairly constructive earnings and economic data. The S&P500 flirted with record highs, and the VIX fell to its lowest level in more than two decades.
- Sentiment soured later in the week as soft inflation data overshadowed a relatively robust retail spending report, with sales up 0.4% atop of an upwardly revised March gain. Total CPI inflation decelerated from 2.3% to 2.2% in April with the core measure slowing from 2.0% to 1.9% on the month.
- Expectations for a Fed rate hike as of June pared back slightly, but remained above 75% through this morning. Unless data continues to disappoint, we expect the Fed will raise rates next month, with another hike likely later on in the year.
Canada
- Canadian housing starts pulled back somewhat in April, but recent strength left the trend measure at 214k units, its fastest pace since late-2012.
- The Canadian dollar was down slightly on the week. The loonie has underperformed its peers so far this year, and speculative short interest has reached all-time highs, reflecting concerns around the health of Canadian housing and mortgage markets.
- At present, fears of a U.S.-style housing crisis appear overblown. The most likely scenario remains that headwinds to the market continue to intensify as we approach 2018, leading to a gradual cooling.
UNITED STATES – SOFT INFLATION DATA PARES JUNE HIKE EXPECTATIONS
Markets started the week off on a forward foot with rising confidence in the global economy, helped by last Friday’s strong U.S. jobs report, further enhanced by the French presidential election results. The price investors demand to protect against volatility dropped, with the VIX falling early in the week, and touching its lowest level since 1993. U.S. equities were also supported by relatively strong earnings reports early in the week, with the S&P500 flirting with the 2,400 point level. Meanwhile a mild rebound in oil prices, following the bullish inventory report, shored up energy stocks since mid-week. The mood soured somewhat by the end of the week as a relatively good retail sales report was overshadowed by weak CPI data.
The election of Emmanuel Macron as President of France, the centrist candidate who ran on a platform of reform, was expected and largely priced in by markets. Still, it was a welcome development for global investors following the protectionist tilt in popular sentiment across many advanced economies over the past year. The result comes alongside some improvement in economic fortunes. This week, the European Union revised higher its Eurozone and U.K. growth outlook, with industrial production and employment growth in France coming in better than expected recently. But, while the new president has some political capital, he faces significant hurdles to enacting the much needed pro-growth reforms, with much riding on the results of the legislative assembly elections to take place in a month.
The U.S. data calendar was relatively light until Friday. The NFIB Index of Small Business Optimism held up well, while labor market strength was further confirmed by a strong job openings in March and a decline in both initial and continuing claims in early-May. Investors also had a number of Fed speeches to digest. Most of the speeches stuck to the script telegraphed by last week’s FOMC policy statement, suggesting the Committee viewed the early-year weakness as transitory, and expected a firming in ‘hard’ economic data during the second quarter. Most Committee members continue to see a fair chance for two more hikes this year, and see the Fed beginning to wind down the balance sheet late this year or in early-2018.
The Fed’s expectations were only partly confirmed by this morning’s data. April’s retail sales were shy of expectations, but nonetheless indicated more consumption momentum into the second quarter given the upward revisions to March spending figures. On the other hand, consumer price data matched expectations for 0.2% m/m as far as the headline print, but came in weaker after excluding food and energy prices with the core measure up a mere 0.1% m/m. After the unexpected decline in March, the softness in April, which saw the headline and core inflation measures slip to 2.2% and 1.9%, respectively, is likely to somewhat quiet those worried about the Fed falling behind the inflation curve.
While the soft CPI numbers may embolden a more dovish tilt within the FOMC, we believe that the strong April producer and import price data, which typically leads consumer prices, should help support the case for a rate hike. Moreover, while the soft CPI data has slightly pared back expectations for a move next month, markets continue to price in odds near 75%. Ultimately, unless the data continues to disappoint, we don’t expect the Fed will pass on the opportunity to raise rates next month.
CANADA – HOUSING CONCERNS KEEP LOONIE WEAK
It was a light week for economic data in Canada, and accordingly, markets did not see any major moves. The S&P/TSX equity index was down slightly at the time of writing, despite some gains in crude oil prices as the week progressed. Equity markets at the moment appear more focused on events related to Canadian housing markets, including the downgrade of major Canadian banks by credit rating agency Moody’s. Concordantly, the Canadian dollar remained volatile, and appeared likely to end the week down, continuing the theme of weak performance this year.
In the only major economic datapoint of the week, Canadian housing starts pulled back a bit in April, dropping back a notch to 214k units after a red-hot March print (252k). The pullback was relatively broad-based: the volatile multi-family segment saw a sizeable drop (-33k units), but so too did the more stable single family construction (-9k). Ultimately, the pace observed in April is likely more in line with underlying trends, but more near-term volatility in the figures is likely as builders in Ontario digest the recently announced ‘Fair Housing Plan’. Aspects of the plan are positive for housing supply, such as an accelerated project approvals process. Conversely, changes around assignment sale rules may dent demand and crimp future supply.
Despite all indications pointing to robust GDP growth in the first quarter of 2017 and a steady expansion thereafter, sentiment towards Canada appears to have soured recently, reflected in a currency that has significantly underperformed its peers (Chart 1). The U.S. administration’s remarks on NAFTA certainly haven’t helped, but the more likely culprit appears to be perceived weaknesses in the financial system underpinning the housing market. The events surrounding Home Capital Group were a catalyst, with non-commercial (i.e. speculative) short interest in the Canadian dollar spiking following the announcement of further regulatory investigation. Indeed, since then, short interest has continued to climb, reaching an all-time high last week (Chart 2; this week’s positioning data will be published later this afternoon).
Although housing markets are the key risk to the Canadian economy, fears of a U.S.-style housing crisis appear overblown. A string of macroprudential tightening measures in recent years may not have had much of a cooling effect, partly due to falling interest rates, but they have helped to reduce risks by improving underwriting standards. While reliable data on the ‘shadow’ mortgage market is scarce, growth appears to have outpaced the overall market in recent years. Still, such lending is a relatively new phenomenon, and its share of outstanding mortgages likely remains small.
Thus, while the risk of a correction cannot be dismissed, the more likely scenario is one of mounting headwinds. These would take the form of a gradual rise in borrowing costs, stretched affordability, the ongoing impact of past and recent cooling measures, and the potential reduction of credit availability from marginal lenders. Together these should serve to cool the hottest Canadian housing markets as we move into the latter half of the year and into 2018. Some frictions in this process are inevitable, but on balance we continue to expect a gradual, orderly deceleration of housing activity.
