Making sense of the markets this week: July 2, 2023

What’s up with inflation? 

It’s no secret—with respect to stock markets, bond yields and the economy—inflation is still driving the bus. And the joke is that the central bankers are looking in the rearview mirror as they drive. They’re looking at data from the past, as the inflation bus hurtles forward. 

Of course, the bankers want to see lower inflation in the target range of 2%. 

Canada had a meaningful inflation report this past week. And perhaps we’ll give the inflation fight a grade of C-minus. Not great, but we’re moving in the right direction. 

Today’s data: inflation! 📉🥳 https://t.co/6GZB1qIFQl

The headline rate dropped to 3.4% in May (a large but expected decline). Big drops in Atlantic Canada. All now below 3%! #cdnecon pic.twitter.com/w5cVSgbNmO

— Trevor Tombe (@trevortombe) June 27, 2023

Canada’s CPI was in line, at 3.4%. The slowdown was caused largely by lower year-over-year (YOY) prices for gasoline (-18.3%), resulting from a base-year effect (how the past 12 months have affected prices for the month). A spike in the previous year’s timeline will result in a lower reading a year later. Excluding gasoline, the CPI rose 4.4% in May, following a 4.9% increase in April. 

From today’s inflation data, it looks like the entire increase in average prices of goods in Canada over the past year is due to groceries. And these are dropping (as expected). Good news! #cdnecon pic.twitter.com/FmNxcz05zi

— Trevor Tombe (@trevortombe) June 27, 2023

But, here’s the terrible irony: The fight against inflation is creating, yes, inflation. Mortgage-cost inflation due to higher rates was up 29.9% YOY. It is the largest contributor to inflation. Strip out that measure and inflation was up only 2.5% YOY. 

While Canadian inflation continued to cool in May, that progress is unlikely to be enough to stop the Bank of Canada (BoC) from raising rates in July. Improvements in core inflation are slow, thanks to the services side, with inflation picking up in areas such as travel and restaurants. Less inflation for everyday consumer goods and staples is always welcome, but the BoC has likely been counting on that already as supply-chain issues continue to improve. 

Canadians should not expect a reprieve on interest rates until 2024—at the earliest. For many months, I’ve been suggesting that inflation might stick between 3% to 4% and that high interest rates will be the norm for a while. 

Let’s not forget the three inflationary waves of the stagnation era. Of course, we don’t know if history will repeat or rhyme.