FINANCIAL NEWS HIGHLIGHTS OF THE WEEK

  • US retail sales rose by 0.9% m/m, while the control group grew by a stronger 1% m/m. Revisions to the month prior were also positive, suggesting Q1 spending ended the quarter on a firmer footing.
  • Home sales fell by 2.6% m/m to 5.6M units in April, as deteriorating affordability continues to weigh on demand. Housing starts (-0.2% m/m) also recorded a modest decline but remain at a healthy 1.7M units.
  • Inflation continued to accelerate across the G-7 into April as the effects of rising food and energy prices continue to be felt.
  • Moving forward, higher interest rates and reduced real disposable incomes will weigh on demand and help to cool inflation by narrowing the wedge between demand and supply.

U.S. -Spending Through the Pain

US equities extended one of their worst losing streaks since 2008 this week, having now recorded seven consecutive weeks of declines in financial news. At the time of writing, the S&P 500 is down 2% on the week, and a far greater 18% year-to-date. The selloff in stocks fueled a rally in US treasuries, pushing the 10-year yield down by 10 basis points to 2.83% (Chart 1).

Financial News Chart 1 shows the US 10-year yield (left axis) and the S&P 500 (right axis) dating back to the beginning of the year. The 10-year yield has recently slipped from its above-3% to 2.8% recently. Meanwhile, the S&P 500 has recorded declines in each of the last seven trading weeks. Data is sourced from Standard & Poor's and Wall Street Journal.

Sentiment soured early in the week as U.S. brick-and-mortar retailers drastically cut future earnings expectations. The common theme was that they are struggling with higher inflation, wages pressures and rising freight costs, all of which are cutting into profits. The dour reaction from financial markets appears to be rooted in the growing concern that the US economy is on the verge of a recession. Investors interpreted the disappointing earnings as a sign that consumers are already on a more precarious footing, further fanning the recession rhetoric. We see things a bit differently.

For starters, many of these big box retailers operate in an environment where margins have always been relatively thin. Even in “normal times”, their ability to pass-on higher costs to consumers is quite limited given the competitive nature of the retail landscape. This problem has been heightened of late, as retailers moved to replenish severely depleted inventories late last year even as consumer demand was already pivoting from goods in favor of services. Retailers were left holding significant inventory, forcing them to discount some merchandise, cutting further into profits.

Retail sales data for April corroborate the notion that consumer spending remains healthy. Headline sales were up 0.9% month-on-month (m/m), while the control measure was up an even stronger 1% m/m. Removing the effects of inflation from the control group did little to change the story, as real sales rose by a healthy 0.9% m/m. Revisions to the prior month were also positive, suggesting consumer expenditures ended last quarter on a much firmer footing than previously thought. While spending is expected to remain robust over the near-term, the combination of higher interest rates and persistent inflationary pressures will present a material headwind in the second half of this year and into 2023. Spending is expected to moderate to a sub-2% pace, though remain supportive of underlying economic growth.

Financial News Chart 2 shows US existing home sales (measured in millions of units) on the left axis and median home prices (measured in year-over-year terms) on the right axis. The chart dates back to January 2019 and includes data through April 2022. Home sales have now fallen in each of the last three months, while median price growth is sustained at close to 15% y/y. Data is sourced from the National Association of Realtors.

Outside of consumer spending, higher interest rates continue to weigh on housing demand. Existing home sales fell for the third consecutive month in April, falling by 2.4% m/m to 5.6M units (Chart 2). Inventory remained incredibly tight, though the pullback in sales did allow supply to nudge a touch higher to 2.2 months – from 2 months in March. Even still, the market remains undersupplied, which is helping to sustain double-digit price growth of 14.8% y/y.

Housing supply relief is coming, but it is taking longer than expected to come to market in other financial news. Despite recording a modest pullback in April, housing starts remained at a healthy 1.7 million units, while permitting activity continues to point to further gains in construction activity in the months ahead. The combination of softening demand and increased supply should go a long way in rebalancing the market over the coming months, and better align price growth to underlying fundamentals.

Thomas Feltmate, Director | 416- 944-5730

Global- Energy Prices Eat into Buying Power

It’s inflation week in the G-7 as the European Union, the U.K., Canada, and Japan all released detailed April inflation numbers. The U.K. made headlines as the consumer price index (CPI) measure reached an eye-watering 9.0% year-over-year (y/y) – the broader measure that includes home ownership services advanced by a more modest 7.8%. Even in Japan inflation hit a seven and a half year high as headline CPI growth reached 2.5%. In general, the surge in energy prices is the rising tide that is lifting the cost of living at a multi-decade high pace.

Chart 1 shows the year-over-year percentage change in the consumer price index for Canada, France, Germany, Italy, Japan, the U.K., the U.S., and the euro area. There are two measures for each country, the headline and core (excluding food and energy) measures. For all countries headline inflation is well ahead of a 2% target, except for Japan where it is still below.

Headline CPI for April in the euro area was 7.3% y/y, while the measure excluding food and energy moved to 3.8%. By comparison, the U.S. registered 8.3% headline and 6.2% core advances, while Canada’s release this week showed a 6.8 % and 4.6% increase (Chart 1). The magnitude of the energy shock Europe is witnessing now can’t be understated. Energy prices are up 37.5% y/y, 7.3 percentage points ahead of the U.S. and a whopping 11.1 percentage points more than Canada. In the U.K., April saw the semi-annual adjustment to price caps on retail energy products. The cap increase produces abrupt jumps in energy costs followed by relative lulls (like a staircase) that ultimately tracks with the smoother European price profile (Chart 2).

Chart 2 shows the energy component on the CPI in the euro area and U.K. The chart shows both measures are up well over 30% year-over-year and track each other rather closely. Indeed, the price increases in the U.K. follow a step wise path as regulators adjust prices on a semi-annual basis.

That said, core measures (excluding food and energy) of inflation in most of the G-7 countries are well ahead of policymakers’ targets. This reflects demand continuing to outstrip supply as the global economy reckons with a sequence of supply-side shocks.

As inflation continues to accelerate central bankers are concerned about longer-term inflation expectations rising and the entrenchment of a wage-price spiral in financial news. That’s a key part of the reason why they continue to signal more monetary tightening despite the risk of a slowdown in growth.

Higher interest rates will work to weaken demand growth, albeit with a lag. The effect of inflation on purchasing power will be more immediate. Measures of wages in the U.K. and Europe are not keeping up with inflation. Average weekly earnings in the U.K. (adjusting for purchasing power) are up 3.5% y/y but, when bonuses are excluded, underlying real wages are down 2.0%. Euro area measures are released with a significant lag, but collectively bargained pay in Germany and Italy (which generally track underlying wage growth) are also lagging inflation. Notably, real hourly contractual wages in Japan were up 1.3% in March. However, in general, wage growth is not keeping up with inflation, so consumers will either be tapping accumulated savings or scaling back on purchases.

Moving forward, output growth will slow through the latter half of the year as inflation and higher interest rates erode purchasing power and slow expenditures. The softer demand backdrop will also help to cool inflation as the wedge between demand and supply narrows in further financial news.

Andrew Hencic, Senior Economist | 416-944-5307

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