This week started off relatively quiet but ended quite loudly, with geo-political developments in the Middle East taking center stage after Thursday night’s retaliatory strikes from the U.S. and U.K. on Houthi forces in Yemen. (Reuters) The strikes were a result of recent attacks on U.S. and U.K. forces in the region, in addition to attacks on shipping lanes in the Red Sea by the Houthi rebel group, which are backed by Iran. The implications of these strikes are that they reflect a potential escalation of conflict in the Middle East. The reaction of markets has been relatively muted, with Brent Crude rising 1.2% on Friday but remaining well below the highs we saw in October, and fixed income markets pricing in the potential for a moderate slowdown in global growth. Should conflict in the region break out, it is quite difficult to calculate with certainty how markets will be impacted – but in sum the reaction would certainly be a negative to equity and fixed income markets in the short-term. For now, the conflict does not pose a serious deviation from our tactical investment recommendations – as we already anticipate a modest slowdown in economic activity globally for the first half of 2024. Furthermore, this conflict is not expected to impact the trajectory of global inflation which is key to a return to normalcy in economic activity.

 

Speaking of which, U.S. inflation came in moderately higher than expected for the month of December at 3.4%, up from 3.1% in November and above the consensus expectation of 3.2%. (RBC Economics) This increase was driven primarily by energy prices (less gasoline) and shelter costs. Gasoline prices remained largely unchanged and were down 1.9% from January 2023. Food inflation slowed down by 2.7% on an annualized basis in December, providing some relief for the consumer. Looking at core inflation in the U.S. and excluding food and energy products, core price growth also slowed – though only by 0.1% on a month over month basis. The going concern remains the impact of a higher interest rate environment, as approximately 70% of the 0.3% the MoM increase in inflation in the U.S. can be attributed to shelter services which were up 0.4% from November and 6.2% YoY. The reaction from central bankers in the U.S. was relatively calm, as the follow-up commentary from several Federal Reserve members on Thursday drove home their expectation that rates will need to stay higher, but the likelihood of future increases is quite low. Reinforcing the narrative that inflation is maintaining a downward trajectory in the U.S., Friday morning’s PPI (Produce Price Index) numbers beat estimates reflecting a decrease of 0.1% from November. (Reuters) For now, allocating fixed income in both short- and long-term bonds is the ideal strategy to take advantage of the higher rate environment and the anticipated decline we assume will arrive in the latter half of 2024.

 

Here at home the recession narrative continues to be front of mind. Though we have not entered a technical recession, economic data out of Canada has been less than supportive of growth in the country. Firstly, we had the December jobs data last week that reflected a nearly flat increase of 100 jobs in the month, concerning given December is typically a month where we see an abnormally high lift in employment data among part-time workers due to the holiday season. Secondly, another key support for Canada entering recession imminently is that real GDP growth in October remain unchanged. (RBC Economics) This was the fifth month in a row in which GDP growth remained stagnant and it is reasonable to assert that this trend would have continued lower through the end of the year, especially given the recent jobs data report I noted above. Moreover, there was a 0.7% decline in hours worked in the month of November which would correlate with a decline in economic output, not an increase that would support a rise in GDP. For now, focusing on quality and staple investments in the Canadian equity space remains our recommendation. With regards to Canadian fixed income, we’ve already noted a moderate decline in mortgage lending rates by financial institutions, indicating that the path towards a lower-interest rate environment may arrive sooner than expected. Keep in mind that fixed rate mortgage pricing is tied to the fixed-income market – you may find this article in Forbes helpful: How Mortgage Rates and Interest Rates Work: 2024 Guide