As close neighbors, the economies of Canada and the US often travel along a similar path. Yet recently, we have seen some divergence in economic fortune. The US recently reported a real GDP increase at an annual rate of 2.1%, and the Fed upgraded its expectation for 2024 GDP to 1.5% from 1.1%. Canada on the other hand was flat month-over-month in July, disappointing expectations for a 0.1% gain and failing to retrace any of the -0.2% decline seen in June. StatCan’s early read on August GDP is for +0.1%. Taken all together, another flat reading for Q3 GDP would be the third in four quarters, signaling that the economy has barely expanded. This sluggish economic growth is surprising considering Canada’s rapid population and labour force growth, which may imply that the country faces a productivity challenge.

In the context of Canada, a stalled economy with stubbornly high inflation can make monetary policy more difficult for its central bank. Softer economic data may dent the odds that the Bank of Canada continues its tightening process with the futures market showing a 1/3 chance of a hike in October and 60% by year-end. The unemployment rate has also increased by 5% to 5.5% over the last four months and consensus call for a tick higher to 5.6% in September.

Unfortunately, this economic softness has not translated into an easing in price pressure with core measures of inflation accelerating. The BoC’s preferred CPI-Trim and CPI-Median both rose 0.44% MoM, pushing the YoY figures towards the 4.0% mark. As the chart below shows, this bucks the recent trend of falling inflation since mid-2022.

Although we do not believe that Canada is heading back to the inflation levels of 2022, Canada’s inflation path is in direct contrast to their neighbors to the south.  The US Fed’s preferred inflation indicator, Core PCE, fell to 3.9% from 4.3% a month prior. On a monthly basis it increased a mere 0.1% for the month of August, which was lower than the 0.2% expected. This is also represents the smallest monthly increase since November 2020.

There is a prevailing theory that “bad economic news” is “good news” for the market and “good economic news” is “bad news” for the market. This view portends that weaker economic data will deter the central banks from raising interest rates which would be a positive outcome for stocks. However, we believe that good news will always be good news and bad news will always be bad news, even if it takes time for the market to view it as such. Ultimately, a “good economy” can only be problematic for the market if inflation is rising. However, if inflation continues to cool amidst a resilient economy, this is (by definition) the soft landing that all parties hope to be achieved. This appears to be the path that the US is on. Similarly, a “bad economy” can only be good for the market if inflation is falling as it would signal that the central bank’s tightening endeavors are working to cool the economy. Unfortunately, the recent combination of sticky inflation and lackluster economic data from Canada is a warning that the effectiveness of central bank policy may be waning.

We submit to investors that inflation continues to be the main indicator to track. Although GDP and labour data should not be ignored, we believe that the overall inflation trend should influence asset mix decisions to a greater degree. As it relates to North America, this suggests that investors should keep a more careful watch of Canada’s inflation trends which appear more stubborn relative to that of the US.