To my clients:
An announcement to my clients that I will not be in the office next Friday as I take an extended weekend with my family. I’ll be connected while away. That said, I do not intend to write an update next week unless circumstances warrant. If circumstances do warrant a comment or two, I’ll likely send the update out on Thursday afternoon instead of Friday.
It was a mixed week for North American stock markets with the Canadian TSX finishing down 0.3%; the U.S. Dow Jones Index up 1.5%; and the U.S. S&P 500 up 0.8%.
The divergence in markets returns between Canada and the U.S. this week is almost exclusively the results of central bank comments and outlook. Specifically, in the U.S., Federal Reserve Chairman Jerome Powell testified before Congress and all but announced that a rate cut would be coming at the end of July. It would seem that whatever doubt might remain lies entirely in the magnitude of the cut – 0.25% or 0.50%? – and not in its certainty. At this stage, RBC views the anticipated cut as an “insurance” cut meant to prolong the current economic expansion. That being said, Mr. Powell did highlight the growing impact of trade uncertainty with China (and elsewhere), and it would probably be wise to monitor this situation with even greater interest and awareness than I have in the past. To date, I have resisted over-reacting to trade tensions as I feel both sides are self-motivated to get a deal done. I still feel this way. But, there is a definite, and perhaps growing, risk that perhaps one side or the other (although I’d wager on China) might be more resolute in their intransigence than the other. That’s a risk I may have to begin accounting for – via portfolio adjustments - in the looming future. I’m not there yet, but it’s an active consideration on my part.
North of the border, Bank of Canada (BOC) governor Stephen Poloz also highlighted the risk of growing trade tensions to the economic outlook, however he was far less definitive in the need to cut rates than his American counterpart (and, for that matter, other central banks around the world such as Europe and Australia). The take away message from Poloz was that rates will remain steady, although his verbiage was such that he left room for the BOC to change course if needed. My feeling is that if the U.S. cuts rates, Canada will have no choice but to follow. Canada already suffers a competitive disadvantage owing to corporate tax rates (which were lowered in the U.S. earlier in Trump’s term), and adding higher interest rates (and the corresponding effect of a higher Canadian dollar) to the mix does not seem to be a sustainable path for Canada to follow.
I’ll finish this week’s comments with a few thoughts on the U.S. labor market. As readers will know, perhaps the most important secondary indicator of recession that RBC follows is the trend in weekly jobless claims which are announced every Thursday. Yesterday’s report showed that weekly jobless claims again dipped after a recent mini-trend upwards. Overall, jobless claims remain near multigenerational lows in absolute terms, and all-time lows in relative terms. Low jobless claims are a “good thing”. Add to this a return to over 200,000 new jobs created in the U.S. last month, as well as an ultra-low unemployment rate, and the U.S. labor market cannot be described as anything other than “very strong”. Historically, such strength has been accompanied by rising wage inflation which, in turn, is a key ingredient to economy-wide inflation. However, this historical correlation has been breaking down in recent decades, to the point where Jerome Powell all but said in his Congressional testimony this week that (I’m paraphrasing here) it is nearly non-existent. Why this is the case, no one really knows, and I’m sure many future PhD theses will be written on the topic, but by acknowledging the breakdown in the historical correlation, Powell also asserted that the “neutral” interest rate (i.e. where rates are neither stimulative nor restrictive of economic growth) was likely lower than what the Fed had been building into its models. In other words, this was another argument for a rate cut coming at the end of the month, and it may be an argument for structurally lower rates for the indefinite future.
That’s it for this week. All the best,
Nick Scholte, CIM, FCSI
Vice-President & Portfolio Manager
RBC Dominion Securities Inc. │ Tel: 604.257.7569 │ Fax: 604.235.9950
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