How are the markets responding to geopolitical tensions?

Key Concepts

• Inflation Rate: The rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling.
• Year-over-Year (YoY) Inflation: Comparing the inflation rate to the same period in the previous year.
• Month-over-Month (MoM) Inflation: Comparing the inflation rate to the previous month.
• Core Inflation: Inflation excluding volatile items like food and energy.
• Seasonally Adjusted Inflation: Inflation figures that have been adjusted to remove the effects of predictable seasonal fluctuations.
• WTI (West Texas Intermediate): A benchmark price for purchasing oil.
• Bank of Canada (BoC): Canada’s central bank, responsible for monetary policy.
• Mortgage Interest Costs: The cost of borrowing money to purchase a home.

Inflation Report Analysis: December 2023 & Bank of Canada Outlook

Inflation Overview – December 2023

The Canadian inflation rate reached 2.4% year-over-year in December. Constantine Bulmer, Head of Fixed Income and Portfolio Management at Mackenzie Investments, discusses the nuances of this figure, emphasizing the impact of the 2024 tax holiday. He notes that the YoY number is artificially inflated due to comparison with lower prices from the previous year when a tax holiday was in effect. Therefore, month-over-month figures are more indicative of current trends.

Sector-Specific Price Changes

• Airline Fares: Experienced a significant 35% increase month-over-month. Bulmer attributes this to typical seasonal patterns in December, noting that Canada doesn’t utilize seasonally adjusted inflation figures like many other countries. Anecdotally, he suggests that travel volume may have actually decreased despite the price hike.
• Groceries: Continue to rise, increasing by 5% annually, with specific categories experiencing notable spikes. Bulmer acknowledges the ongoing pain felt by consumers at the grocery store but doesn’t offer a definitive explanation for the continued increases, citing tariff uncertainty as a potential factor.
• Gasoline Prices: Decreased by over 7%, providing a marginal offset to other price increases. This decline is linked to a drop in oil prices, with WTI (West Texas Intermediate) currently trading around $60. However, Bulmer cautions that gasoline prices are influenced by refining costs and that oil prices are approaching a break-even point for producers, limiting further significant declines.

Core Inflation & Mortgage Interest Costs

Core inflation metrics are showing signs of moderation. A key contributor to this trend is the decline in mortgage interest costs, which have leveled off and are now potentially having a negligible impact on the year-over-year inflation rate, and even a slight decline month-over-month. This is a direct result of the interest rate cuts implemented by the Bank of Canada. Bulmer notes that this factor hadn’t been widely recognized as a significant inflation signal.

Oil Prices & Gasoline Price Dynamics

While oil prices have fallen, they don’t directly translate to lower gasoline prices due to refining costs. Current oil prices are hovering around the break-even point for producers, suggesting limited potential for further substantial declines in gasoline prices. Bulmer highlights that oil prices around $60 represent a threshold that is difficult to breach downwards.

Bank of Canada Rate Cut Expectations

Despite current inflation figures appearing well-behaved, Bulmer anticipates the Bank of Canada will resume cutting interest rates later in the year, potentially as early as April or during the summer months. This contrasts with the prevailing market expectation of a potential rate hike by year-end.

Bulmer’s reasoning centers on continued weak economic growth, a challenging housing market, and the lack of renewed optimism. He believes these factors will negatively impact employment and consumption, ultimately forcing the Bank of Canada to lower rates to stimulate the economy and, specifically, to reinvigorate the housing market. He doesn’t foresee rate cuts at the next two meetings (January/February and March).

Quote: “Inflation looks pretty well behaved…economic growth still is weak. The housing market is in a very difficult situation. There doesn't seem to be any reason for renewed optimism coming back.” – Constantine Bulmer.

Logical Connections

The discussion flows logically from a broad overview of the December inflation rate to a detailed examination of specific price changes. The analysis then connects these changes to broader economic factors, such as interest rate policy and oil prices. Finally, it culminates in a forecast for future Bank of Canada actions based on the observed trends.

Data & Statistics

• Inflation Rate (December): 2.4% year-over-year.
• Airline Fares: Up 35% month-over-month.
• Groceries: Up 5% annually.
• Gasoline Prices: Down over 7%.
• WTI Oil Price: Approximately $60.

Conclusion

The December inflation report presents a mixed picture. While the headline number is elevated due to the tax holiday effect, underlying trends suggest moderating core inflation, driven in part by declining mortgage interest costs. However, persistent grocery price increases and volatile airline fares remain concerns. Bulmer’s key takeaway is that the Bank of Canada is likely to resume rate cuts later in 2024, driven by concerns about weak economic growth and a struggling housing market, despite current market expectations leaning towards potential rate hikes. This perspective is based on a belief that economic data will weaken in the coming months, prompting the central bank to act.