Global markets jumped higher today with softer-than-expected U.S. inflation data. Bond yields moved lower. Mid-term elections dominated U.S. headlines. While the developments were headline-grabbing in nature, we do not view the investment outlook as having meaningfully changed.
On November 10th, the October reading of the Consumer Price Index (CPI) in the U.S. was released. The index rose 7.7% year over year, suggesting that inflationary pressures are still very high. Nevertheless, the reading was below most forecasts, and marked a deceleration from the previous month. The October release adds some credence to the view that the U.S. may be past the worst of its inflationary pressures.
The weaker inflation data is also likely to fuel the debate around when the U.S. Federal Reserve will be able to slow its aggressive rate hiking campaign. The Fed recently raised interest rates by 0.75%, the fourth consecutive outsized move. More noteworthy were Mr. Powell’s comments, in which he stated that the pace of future rate hikes will inevitably slow at some point, similar to the messaging from other central banks (including the Bank of Canada). He affirmed, however, that it is premature to talk about a pause, and strongly indicated that rates will still have to be higher and more particularly “sufficiently restrictive” to slow the economy, reduce inflation, and most importantly ensure future inflation expectations stay contained. This commentary left investors wondering whether rates will go higher than previously expected, and also remain so for a longer duration.
The U.S. mid-term elections took place this week. The results have not been finalized as there are still races that are too close to call. The Republican Party did not dominate to the extent that was expected, as some projected that the GOP would take a decisive amount of seats in both chambers of Congress: the Senate and the House of Representatives. The outcome was, however, in-line with general expectations: a divided government, with the Presidency occupied by one party and one or both chambers of Congress occupied by the other. A divided government will make it challenging to pass any meaningful legislation over the next two years. Nevertheless, this kind of a setup has historically proven to be a positive tailwind for equity market returns, particularly after mid-term elections.
Politics aside, the investment outlook, in our view, is unchanged. Inflationary pressures remain high but should weaken over the next year, driven by a combination of factors such as lower commodity prices, supply chain normalization, tighter financial conditions and less challenging year-over-year comparisons. As inflation slows, so too should the pace of interest rate hikes from central banks, which should lead to greater market stability, particularly in the bond market. Economic momentum should also fade as this year’s rate hikes begin to more fully impact the behaviour of consumers and businesses. A recession seems almost inevitable, but it may take some time to develop. The North American economies have proven to be resilient, with businesses still looking to hire and consumer spending remaining robust. We expect these conditions to eventually change at some point in 2023.
Challenges lie ahead. The markets have undergone a significant repricing this year given the inflationary backdrop. The repricing has resulted in a wide range of income-producing opportunities that look relatively attractive. We intend to explore some of these for our portfolios, based on our view that income will be an even more important contributor to total returns for our clients over the coming year.
If you have any questions, please do not hesitate to contact us.
Drew M. Pallett LL.B. CFP
Senior Portfolio Manager and Investment Advisor
RBC Dominion Securities
Email: drew.pallett@rbc.com
Website: www.pallett.ca