Executive summary:
- U.S. inflation eased further in June, strengthening the case for a Fed rate cut in September
- June's inflation report could sway Canada's central bank to hold off on a second rate cut
- Additional stimulus measures may be announced at China's upcoming Third Plenum meeting
On the latest edition of Market Week in Review, Investment Strategist BeiChen Lin and Regional Director Chris Kalman discussed the highlights from June’s U.S. inflation report. They also chatted about how Canada’s June inflation numbers could impact the Bank of Canada’s (BoC) next decision on rates, and finished with an overview of what to expect at China’s Third Plenum meeting.
‘Encouraging’ U.S. inflation report for June
Kalman and Lin began with a look at the main takeaways from the U.S. consumer price index (CPI) report for June, which was published July 11 by the Labor Department. Lin characterized the report as good news from an economic perspective, with core inflation rising just 0.06% from May, versus consensus expectations for a monthly increase of 0.2%. Meanwhile, headline inflation eased from 3.3% in May to 3% in June, he said.
“These latest numbers show that the U.S. Federal Reserve (Fed) is continuing to make progress in its quest to bring inflation back down to its 2% target,” Lin remarked. He emphasized that importantly, the second quarter was marked by an overall slowdown in consumer prices—a welcome change from the first three months of the year, when consumer prices largely reaccelerated.
Lin believes the Fed will likely be successful in lowering inflation to 2%, although he stressed that not every single report will show a linear decline. Overall, though, he said the June CPI report in particular is encouraging and strengthens the case for a September rate cut from the Fed.
The market reaction to the U.S. inflation numbers was somewhat interesting, Lin said, pointing out that large cap equities—as measured by the S&P 500® Index—actually fell slightly on July 11. Why? He said it’s probably because so much optimism has already been baked into large cap U.S. equities, which repeatedly reached new highs in early July. “Our propriety measure of investor sentiment suggests that sentiment is directionally overbought and is getting close to—but not quite at—a level of euphoria,” Lin explained.
He noted that conversely, small cap equities actually performed well in the wake of the June U.S. inflation report, with the Russell 2000® Index of small cap stocks rising sharply on July 11. “This favorable reaction can be partially attributed to the fact that small cap equities are generally more rate-sensitive than large cap equities. With markets becoming more confident the Fed will be in a position to cut rates soon, the sharp tick upward among small cap equities makes sense,” Lin stated. However, he added that even with their strong performance on July 11, U.S. small cap stocks are still lagging significantly behind their large cap counterparts so far this year.
All eyes on Canada’s June’s CPI numbers
Shifting the conversation to Canada, Kalman noted that the country’s June CPI report will be published on July 16. Lin said that in light of May’s unexpected increase in inflation, the June numbers will be absolutely critical in determining if Canada’s central bank can cut rates again. The June report will be the last big economic report the BoC sees before making a decision on rates at its July 24 meeting, he explained.
“The Bank of Canada is in a bit of a tough spot right now. On the one hand, a look at growth dynamics in Canada—particularly in the labor market—shows that the jobs market in Canada is much weaker than in the U.S., with the Canadian unemployment rate rising in June. Based purely on labor market dynamics, it’s reasonable to think the BoC should cut rates at its next meeting, as it did in early June,” Lin said.
However, a look further under the surface of the June employment report shows that wage pressures actually accelerated last month, he explained, adding that there’s a pretty good connection between wage pressures and inflation in the services sector. “Services inflation was a bit on the sticky side in May as well, making this a complicating factor in the BoC’s upcoming decision,” Lin said.
Ultimately, Lin believes that if the June CPI report shows an easing in core inflation, the BoC will probably be in a good spot to lower borrowing costs again later this month. On the contrary, if core inflation remains stuck at—or slightly reaccelerates from—its current level of 2.7% (year-over-year), he thinks it’s more likely that the BoC will have to defer a second rate cut until September.
Is more stimulus on the way in China?
Kalman and Lin wrapped up the segment by discussing key investor watchpoints for China’s Third Plenum meeting, which takes place July 15-18. The Third Plenum is one of China’s main policy meetings, Lin said, noting that many investors are expecting the Chinese government to unveil additional stimulus measures at the 2024 meeting.
Lin explained that China has announced a 5% GDP (gross domestic product) growth target for the year, which, from his vantage point, looks difficult to achieve without more stimulus. “I think the Chinese government is very committed to hitting this 5% target and is willing to deliver as much stimulus as needed to reach this goal,” Lin said. He expects that additional stimulus measures will be announced at the Third Plenum, and said he’ll be carefully watching to see the type and magnitude of any potential stimulus, as well as what sectors the stimulus is aimed at.
“China’s property market is in a tough spot, as is consumer confidence, so it’ll be interesting to see if any potential stimulus is aimed in either of these directions,” Lin concluded.
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