Volatility remains relatively subdued as the concerns about the banking sector that arose in early March have subsided. With that in mind, some of the fundamental issues that had been front and center over the past year have come back into focus.

 

Inflation is a normal part of a well-functioning, and growing, economy. Inflation rates tend to vary over time despite the fact the Bank of Canada and U.S. Federal Reserve have goals of maintaining long-term inflation rates around 2%. For example, the annual change in the Consumer Price Index ranged from 1% to 3% over the past 25 years, with the exception of a few occasions before and after recessions when inflation fell meaningfully only to bounce back along with a recovery in growth. All that changed, rather sharply, in 2020 with the reopening of the global economy after the pandemic-induced shutdowns. At their peak last year, inflation rates in North America surpassed 8%.

 

There has been notable progress with inflation receding over the past year. The most recent reading of headline inflation in Canada and the U.S. was 5.2% and 5.0%.  We have clearly transitioned from a “high and rising” period of inflation to one where inflation is “high and falling”. That subtle change has translated into more stable returns across asset classes of late and it’s the primary reason the year has been more rewarding for investors so far, than in 2022.

 

The U.S. Federal Reserve may raise rates yet again when it meets next month. Minutes from its March meeting revealed that it had intended to raise rates by 0.5% but grew more cautious in the wake of some signs of stress in the banking sector. Even the Bank of Canada struck a similar tone over the past week despite keeping its policy rate on hold. It suggested that while progress has been made, the economy has been stronger than expected, and may require more time and potentially more action on its part to get inflation within the vicinity of its targets.

 

The bottom-line is inflation trends have improved and are on the right trajectory as tighter financial conditions drive goods and services prices lower over time. That should remain a tailwind for stock and bond prices.

 

Tim