Uptick in inflation may push peak rates higher
Globally inflation has been cooling since it peaked in early 2022 partly due to falling energy prices, partly due to prices of durable goods as the supply chain continued to heal. However, January’s inflation data surprised to the upside in the US, Germany, and Japan, with pick up in spending on goods and services, including motor vehicles, food services, and accommodation. While consumer demand for goods is starting to fall in the U.S, consumption of services is still above trend. The combination of jobs gains, higher consumer demand, and rising wages will continue to put pressures on service inflation.
With tight labour markets and stubborn inflation, the Federal Reserve has, towards the end of the month, doubled down on their hawkish rhetoric and expressed the need to raise rates further. Bond markets sold off quickly, 10-year government yield rallied from a low of 3.39% in early February to end the month at 3.92%. The expectation for peak rate in the US also moved much higher, from under 5% to over 5.5% in June 2023. The market no longer expects meaningful rate cuts by the Federal Reserve in 2023. Current expectations are for rates to remain above 5% through early 2024. Bank of Canada is the only central bank that is believed to have reached the end of this tightening cycle and is expected to stay on pause till the end of this year.
Source: Bloomberg data as of November 30, 2022
Bank of Canada is the only central bank that is believed to have reached the end of this tightening cycle and is expected to stay on pause till the end of this year.
Earnings estimates continue their downtrend
Earnings estimates for 2023 and 2024 have continued their downward trend since mid-2022. While some companies have been able to surprise with their recent quarterly results, the trend at the overall index levels continues to be downward. Companies have been able to grow revenues enough to offset the drop in margins. Profitability is showing early signs of stabilization, as inflation moderates, and supply chains heal. However, earnings growth is still expected to be anemic given the decline in demand amidst tightening financial conditions, and if layoffs pick up steam. Lower profit margins will also impact future earnings, though profit margins remain relatively stable as producer prices have dropped sharply since their peak.