Good news on the inflation story in the U.S., it is going down! Headline CPI in the U.S. decelerated to 3.0% YoY in June, down from 3.3% in May. The closely watched super-core measure posted a second consecutive outright decline (-0.04% in May and -0.05% in June) to leave the three-month annualized basis down to 1.3% in June. That is the slowest reading since October 2021 and just half of the pre-pandemic run rate of 2.6%. However, the PPI (Producer Price Index) crept up in June to 2.6% from 2.4% in May. Fortunately, the monthly increase in May-Jun of 0.20% annualizes to 2.4% so the trend remains closer to the Fed’s 2% target on this figure as well. (RBC U.S. Inflation Watch - RBC Thought Leadership)

 

What does this mean for your portfolio? Firstly, that Fed rate cuts are coming and sooner than expected. Provided CPI continues this downward trend though July and August, our expectation is for the first 0.25% rate cut from the Fed to arrive in September. This will give a much-needed boost to small- and mid-cap companies in the U.S., though a more meaningful decline in interest rates will be needed to improve their growth prospects and potential to enhance your investment portfolio. Second, an anticipated decline in rates means that the opportunity in U.S. fixed income is closing from the perspective of maximizing the long-term passive return in your portfolio. As short-term rates decline, so will long term rates and conversely the coupon (interest) income you can generate on medium and long-term U.S. fixed income.

 

It was a quiet week here at home regarding economic activity, however a piece from BNN Bloomberg (Read Here) this week is worth the 2-minute read.  It highlights the fact that the breadth of the rally on the TSX this year has been much for every equity position that has declined this year, two have risen. That is vastly different from the significant concentration in U.S. equities, especially on the S&P 500 where seven tech stocks have dominated the direction of the index’s performance. It is worth noting that U.S. equities have most certainly outperformed those here in Canada, case in point the S&P 500 YTD is up 17.08% versus the TSX at 7.57% - but this underscores the importance of ensuring your portfolio is well diversified. For a balanced investor, we currently recommend a portfolio be allocated 20% to Canadian Equities and 20% to U.S. Equities.

 

Overseas in Europe, the inflation focus remains but more so on the pace of rate cuts in the near term. The UK interest rate market turned more hawkish on the prospect of an August Bank of England (BoE) rate cut after digesting first official comments from policymakers after the quiet period of the general election. BoE Chief Economist Huw Pill supported market expectations of an eventual easing in remarks on Wednesday, but highlighted that services prices and wages pointed to uncomfortable strength in inflation (Transformation and conjuncture − remarks by Huw Pill).  In mainland Europe, the ECB's recent focus has been on gradual rate cuts with the ultimate destination for interest rates remaining unclear. Key hawkish policymakers like Wunsch and Knot suggest a reluctance to cut rates below 3%, viewing this level as still restrictive. European fixed income market pricing indicates the potential for the deposit rate to be lowered slightly below 3% by early 2026. However, higher than expected core inflation rates counterbalance this, maintaining concerns about inflationary progress. (BNN Bloomberg)

 

The situation in China remains mixed. Customs exports rose 8.6% YoY in June, beating forecasts of 8% and 7.6% growth in May. Meanwhile, imports unexpectedly shrank 2.3% amid still weak domestic demand, versus an expected 2.8% for June and 1.8% gain in May. This has resulted in a trade surplus of $99.05 billion, the highest since at least 1990 and a dramatic increase from May’s $82.62 billion. Though China continues to perform well globally, it is domestic economy continues to show signs of weakness. In Japan, the Yen spiked more than 2% vs the U.S. dollar overnight in the wake of softer than expected US CPI. This adds to the fact that Japanese households have been experiencing inflation at record levels over coming year. With the recent trend in inflation, it is expected that the Japanese government will slightly trim its forecast for economic growth of 1.3% to about 1% for the fiscal year ending March 2025.