Optimism has certainly improved in equity markets over the last several weeks. Leading up to this week we had seen inflation continue to fall globally, though remaining quite high in certain countries such as the UK and still above central bank targets. However, labour market and economic data in the last several weeks have been reflecting a higher probability of a soft landing for the U.S. economy. This was further reinforced by dovish commentary from the Federal Reserve and Chairman Jerome Powell on Wednesday as they indicated that the rate hiking cycle is over and that all members of the board are no longer writing in rate hikes into their forecast for 2024. (RBC Economics) This is a notable change, as the focus now becomes on when the Federal Reserve begins to cut rates – likely lagging other economies, such as Canada, who have real recessionary pressure to contend with that may necessitate rate cuts earlier in 2024.  Inflation has also come down meaningfully in the U.S., further supporting this narrative. (RBC Economics)

 

This shift in the direction of the Federal Reserve’s outlook into 2024 can be seen in their most recent Summary of Economic Projections released on Wednesday.  Their expectations for real GDP Growth (1.4%), the unemployment rate (4.1%) and Core PCE Inflation (2.4%) for 2024 remained unchanged from their outlook in September. What is a noticeable divergence is the expectations of where the Fed Funds rate will be at the end of next year. In September they had forecast the median target funds rate would be 5.1% (effectively 5%) however in this week’s outlook they have forecast a median target fed funds rate of 4.6% (effectively 4.5%). Given the current Fed Funds rate is 5.5% this effectively means the Fed is forecasting 100 basis points (1%) in cuts. This aligns with what fixed-income markets have been pricing in over the last month and provides further assurance that material rate cuts are coming in 2024.

 

Fixed income investments remain attractive from both a coupon payment (interest income) perspective as well as the opportunity for capital appreciation as rates fall over the next 24 months. The current rate environment has generated a rare investment opportunity that we have not seen since 2007, but, likely, interest rates will not return to the ultra-low levels of the 2010s. We do expect fixed-income markets to return to historically normal levels experienced before 2007 and the implementation of significant quantitative easing resulting from the Financial Crisis that kept rates lower for a decade and a half.

 

In Canada this week the focus remained on the housing market, primarily on the impact of interest rates and a meaningful decision from OSFI (Office of the Superintendent of Financial Institutions) to keep the current mortgage stress test rules in effect.  (BNN Bloomberg)  Affordability issues continue to be an ongoing concern for mortgage lending activity and home buyers.  Home resales have declined 13% Canada-wide since June as buyers struggle to qualify for mortgages and sellers are not able to attain the sale price that they have targeted in their minds. This aligns with the reality here in Toronto that home prices in November fell -1.7% on a MoM basis and remained flat YoY at +0.1%. (RBC Economics) 

 

This concern in mortgage markets did not stop the euphoria of an end to the current rate cycle in the U.S. positively impacting markets here at home. The TSX this week saw a significant lift, notably due to improved valuations in Canadian banks which have experienced notable retreats in their valuations since the summer. Canada is most certainly experiencing a mild recession. Given the improved outlook on the inflation front and in credit markets, we expect a continuation of the current recession to persist into 2024 but the probability of a deep and prolonged recession continues to decline. For more on our outlook for the Canadian economy next year you can find our full commentary here: Global Insight 2024 Outlook: Canada

 

The Chinese government announced on Friday that it will be injecting another $112 billion US in one-year loans to commercial lenders to spur business and retail investment.  (Yahoo Finance)  This was coupled with an easing in restrictions on home buying in Beijing and Shanghai.  The government and regulators have quite the task ahead of them in 2024, as they aim to maintain liquidity in markets for the economy to continue to grow but are faced with the threat of declining consumer confidence and foreign investment. Retail activity and real-estate investment continue to be in contraction, though this week there were positive signs that manufacturing activity was beginning to improve. The real estate market in China accounts for approximately 20% of their economy, so fixing the problem remains a key concern for the Chinese government though the issue may not resolve itself until credit markets loosen in 2024 as rates decline globally.

 

In Europe, the ECB this week also kept their overnight lending rate unchanged but did improve their outlook for 2024. In their most recent projections, the ECB forecast that headline inflation would fall to an average of 2.7% in 2024 and 2.1% by 2025. This marked improvement and supported by the fact Eurozone inflation fell to 2.4% in November – well below expectations. (EuroNews) .The UK continues to experience higher inflationary pressure than its contemporaries in Europe and North America, with inflation in October coming in at 4.7% but meaningfully down from September’s 6.3% print.  Like the ECB, the Bank of England this week also kept their target rate on hold. Unlike the Federal Reserve, the ECB and Bank of England did not provide any indication that they will be cutting rates in 2024, but as both contend with recessionary pressure this story may change as we make our way through the start of the new year.