Inflation tops expectations… a rate hike now all but assured?; Will Canada be ‘going dutch’?

Inflation tops expectations

Stats Canada released their March inflation readings which surprised significantly to the high side.  While economists were widely expecting a 2.8% year-over-year increase, the actual increase registered at 3.3%, the highest since mid 2008.

Perhaps more significantly, the increase was widespread and not largely concentrated in the energy component of the Consumer Price Index.

Among the main contributors to the jump in inflation were:

• Gasoline (+18.9%)
• Fresh vegetables (+18.6%)
• Passenger vehicle insurance premiums (+4.7%)
• Food purchased from restaurants (+2.7%)
• Fuel oil and other fuels (+31.3%)

The components that experienced the strongest year-over-year decline were:

• Mortgage interest cost (-2.2%)
• Computer equipment and supplies (-9.9%)
• Video equipment (-10.4%)
• Fresh fruit (-3.1%)
• Natural gas (-2.0%)

The increase was widespread across the country, with Nova Scotia (+3.9%) and Ontario (+3.6%) leading the pack.

It’s worth recalling that Mark Carney recently stated that the Bank of Canada feels that current inflationary pressures represent short term volatility.  Yet even the Bank must have been surprised by this CPI reading given that they warned that inflation “could reach 3%” by Q2 2011.  We’re well above that currently.

The implications are fairly clear.  The Bank of Canada has a stated mandate to keep inflation, “near 2 per cent — the mid-point of a 1 to 3 per cent target range.”  With inflation now well above the three percent upper boundary, Carney will no doubt be feeling increasing pressure to continue raising rates with a rate hike now very likely in July unless this reading proves to be a one-time spike.

It also bears watching the actions of the bond market today.  It’s very likely that Government of Canada bonds will be under selling pressure, meaning higher interest rates.  Keep a close eye on the 5 year BoC bond, upon which fixed interest rates are set.  As I’ve noted before, this is the key interest rate that now determines the stability of the housing market.

Will Canada be ‘going Dutch’?

It’s worth recalling the recent Macleans article examining the current commodities boom:

Two charts you need to see about commodities and the housing market

And here is that interesting chart relating to commodities:

It’s also worth considering how the recent moves by the People’s Bank of China to rein in inflation via rate hikes and increased reserve requirements will have on commodity demand.

With the US now likely heading back towards near-recession levels of growth later this year, QE2 set to end this summer (likely only temporarily), and with global growth still tepid and set to slow amid supply chain disruptions following the Japanese earthquake and tsunami, the continued bull market in commodities is far from assured.

What might it all mean for Canada if the commodities bull market comes to an abrupt end?  An interesting article in the Globe and Mail pondered this very question.  The article highlights a recent research report from MRB Partners, a Montreal-based investment research company.  (Hat tip to JD for emailing this to me).

When commodities boom ends, will Canada be going Dutch?

Some key quotes:

“Once the current commodity boom ends the loonie will plunge, the economy will stumble badly, wages will fall and complacent policy makers will find out what happens when there isn’t enough growth to compensate for a lack of fiscal prudence.”

“We are constructive about the prospects for the economy and maintain a positive cyclical outlook on Canadian risk assets…Nonetheless, the euphoria needs to be kept in check. Oil and rocks have masked substantial and rapidly growing imbalances that will prove devastating if not corrected before the next global economic recession….(Investors) should be careful not to dismiss these risks.”

“Ultimately, the Canadian economy will fall of its own weight.”

“Energy and agriculture now account for 34 per cent of exports, up from 13 per cent in the late 1990s. Shipments of consumer goods have plummeted by nearly half, to 17 per cent.”

MRB is not advising clients to sell Canada just yet, even though it regards Canadian bonds, stocks and other assets as overvalued. It does warn that a passive, long-term buy-and-hold strategy is a bad idea. “In fact, investors should progressively lighten their holdings as the commodity boom rolls on, especially once global leading economic indicators weaken materially.”

There’s never anything wrong with exploring the potential risks to the Canadian economy.  This report aligns nicely with my own perspective on Canadian assets.  I’m not prepared to sell them yet, but I am watching leading global economic indicators (such as those published by the OECD) and keeping a close eye on China for any indication that a hard landing is shaping up.

Ultimately the growth prospects for Canada are excellent in the long term.  That doesn’t mean that we won’t experience some major headwinds along the way.  More importantly, the Canadian growth story is certainly not new and is far from a secret (as evidenced by the $4.9 billion in Canadian stock purchases made by foreigners in February).  This raises the risk that long-term growth prospects are already reflected in current stock valuations, which are far from cheap.  As discussed before, when the consensus is bullish on a particular asset, it’s the best time to start considering other options that are not as universally loved.



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33 Responses to Inflation tops expectations… a rate hike now all but assured?; Will Canada be ‘going dutch’?

  1. jesse says:

    So is there a “buy” anywhere?

    With UE high it seems reasonable that core will stay low. That is a chronic problem if residential construction is oversubscribed. What industries will fill the void to bring UE down?

    • Patience and discipline is the name of the game in stock picking. Diversification into international markets using ETFs is also a must, as is broad diversification across asset classes.

      There are still some great buys out there, but you really have to look at some seriously out-of-favour companies to find them.

  2. paradox says:

    BoC will not raise rates significantly if at all before the FED moves.
    All public workers (majority of the work force in Canada) and some private companies as well have automatic wage adjustment to inflation rate.
    This is the plan all along. With interest rates severely lagging the inflation rate, a soft landing will be manufactured in the long term.
    Savers are screwed , there is no reasonable hiding place from this inflationary environment, deposit rates at less than 1%, priced out of RE, gold and silver at all time highs as well as PM and stock markets the savers are totally fxxxed.
    So it seems that those still affording to buy real estate are not stupid after all.

    • “BoC will not raise rates significantly if at all before the FED moves.”

      I’m inclined in general to believe that, but it’s hard to see how that is now the case.

      “So it seems that those still affording to buy real estate are not stupid after all.”

      That much remains to be seen. Without the ongoing expansion in credit, things look decidedly different. I’m not sure how much more leverage can be force-fed into consumers, considering consumer debt is well over 90% of GDP. The economic climate looks decidedly different once peak credit is reached.

    • jesse says:

      “Savers are screwed”

      If you have a mortgage, I hate to break it to you, but you’re a “saver” too!!!

    • John in Ottawa says:

      Not raising rates significantly is what I call “tapping on the brakes.” The BoC simply cannot get too far ahead of the Fed. Until very recently, the BoC has not moved ahead of the Fed.

      This latest surge in inflation is being related to producers attempting to pass commodity prices through to consumers. There isn’t a lot the BoC can do about commodity prices.

      If some sizzle needs to be taken out of consumer debt growth, I still prefer the route the government has been taking lately of tightening regulations. There is still lots of wiggle room available there without touching interest rates.

  3. DancinPete says:

    Hi Ben,

    With any given industrial commodity, how do you know how much of the demand is from actual Use/Consumption of the commodity, and how much is investors, hoping it will rise in price, or people fearing losses in other sectors who are using it as a store of value.

    Basically, I guess I’m trying to determine how much of an impact turmoil in the USD and Euros would have on demand for commodities.

    • Great question. The CFTC releases its Commitment of Traders report every Friday. Large non commercial long positions in commodity futures indicates a higher level of speculation, but you have to be able to compare it to what is historically normal. Significant speculation heightens the risk of volatility, particularly to the down side.

    • John in Ottawa says:

      There can be little doubt that the Fed’s QE has gone straight into commodities. If the Fed ends QE, we’ll see just how much. However, I fear the Fed has painted itself into a corner and will have to continue QE well into the future.

      Remember that, due to a new rule promulgated this January, any losses the Fed takes on its purchases are fed back to the Treasury on a monthly basis. They don’t even show up as a loss on the Fed’s balance sheet, but rather as a negative “Due to Treasury.”

      The US Treasury can’t afford the losses, so the Fed is going to have to keep priming the pump. This truly is the final Ponzi scheme.

      • Howdy There says:

        From an optics standpoint, it’s going to get tougher and tougher to justify QE. As long as money continues flowing into commodities, it will keep pushing up the headline inflation rate. QE = a sure path to stagflation.

  4. jesse says:

    WRT inflation the analogy I’ve used recently is going to ask your boss for a raise because food and fuel costs are 10% higher than last year.

    Situation 1: You go into the office and ask for a raise. Your boss shows you a stack of resumes of qualified people who want your job. No raise for you: drive less and don’t supersize.

    Situation 2: You go into the office and ask for a raise. Your boss has tons of work to do and has been having trouble finding qualified people. He gives you a 10% raise, you proceed to merrily speed home and supersize.

    According to Carney and Bernanke, North America is mostly in Situation #2. The danger of a broad-based “wage inflation spiral” is low. Volatile CPI inflation sucks big time for lower income tiers but it’s not “really” inflation as far as the Central Banks are concerned.

    Asia is a completely different story.

    • paradox says:

      I dont see it quite like that. In our company wages have been rising more than 3% a year and we have difficulty finding qualified people. Yes, I got a 5 % raise this January and so did many others. But maybe this is the exception. I see that the minimum wage was raised as well in BC.

    • jesse says:

      “In our company wages have been rising more than 3% a year”

      There is no BROAD-BASED wage-inflation spiral. There are exceptions in certain government jobs and those with higher incomes and educations, as is true today in the US with certain professions. But most jobs have poor negotiating terms. That does not translate, and is not translating, to core inflation. What you are highlighting is a structural problem, where those with lower educations are being “left behind”.

      It should be no surprise that corporate earnings are now starting to come under pressure. Some have tried to “pass on” higher input costs to consumers but, generally, consumers are unable to absorb the higher costs and sales volumes have commensurately dropped.

      • John in Ottawa says:

        I suspect Paradox is one of the commodity businesses. Things are fantastic until they aren’t. Then everyone is out of a job.

        Boom and bust.

  5. Draat says:

    “Is this time different” “Commodity prices have never risen this fast and high in history without a sharp decline.”
    I know I open myself up to ridicule by saying that it is different this time but it is. This time we have the other half of the planet participating in the boom (China & India). This time the U.S. dollar is is falling fast and other currencies with it which only increase the relative value of commodities – especially those priced in U.S. dollars such as oil. Commodities will correct however the bubble will likely go on longer this time and the correction will never bring the price of commodities down to pre-boom prices. There are just too many fiat dollars being produced which all compete for a finite amount of commodities. I personally think owning energy stocks for the long haul (10+ years) is better than government bonds.

    • John in Ottawa says:

      No reason to ridicule what you have said. What you said is generally true.

      Still, commodities are sensitive to the strength of the world economy. In general, commodities will be in ever greater demand as the developing world increases its prosperity. However, there will be a lot of volatility over the long haul and we will feel that volatility going forward.

  6. mac says:

    Commodities are like real estate. Investors favour parking their money there, including you-know-who… Ben’s “mythical” Asian investor. Were they part of the 4.9 billion in foreign sales of TSX stocks? Is there any difference between what they do on the TSX and on the streets of TO/VAN/MTL? Same investment strategy around the globe. Start to factor it into your analysis:

    Any reversal in commodity prices will just be seen as an opportunity to get in by others. Buy and Hold for global high-end real estate, food, energy, etc. That’s the mantra for the next 10 years for the New Global Elite. Either join ’em in one way or another or get left in the dust.

    On this blog: it’s a no for real estate. A wait-and-see for commodities because a nasty shock is coming. US/TSX stocks are overvalued except for precious few. What’s the way to make money in your scenario? Sideline cash waiting for the crash in all areas?

    • Hyperbole and misrepresentation are indeed your strengths, Mac.

      Once again, the Asian investors are not “mythical”, but they are insufficient to keep house prices at such extreme levels of valuation.

      Did you actually read the link you provided? I had no idea that house prices globally were going to be kept higher by the limitless amount of wealth in China…..currently some $7400 US per person per year.

      I’ve highlighted some of these before, but I had no idea of some of the others…

      Of course, it nicely ignores the issue of falling house prices in numerous other countries around the world……US (including the formerly-in-demand-by-rich-Asians West coast), UK, Australia…..

      It seems that rich Asians keep house prices high everywhere in the world until all of a sudden they don’t. Strange, eh?

    • jesse says:

      “Any reversal in commodity prices will just be seen as an opportunity to get in by others”

      I heard that one before circa 2007, but substitute “commodity” with “US real estate”. The technical term for what you describe is “support”.

  7. mac says:

    No. It seems wealthy foreign investment coming from Asia (and other emerging economies) can keep TRANCHES of house prices high-er than you imagine they should be and prevent them from “collapsing” by 30% (as you have predicted for houses). For condos, pre-sales being snapped up by same foreign buyers, who are now prevented from flipping and hoarding in their home country, keep new condo inventory from coming on market and being part of the inventory needed for your 50% “collapse” (as you have predicted for condos). I believe this is called globalization.

    This creates a prolonged bifurcated market which is now becoming clear as a bell in Vancouver, which is similar to the other cities where there have been great declines in the state or county but not so much in “desirable areas” in the major cities. Hence my prediction many moons ago of continued increases in SFHs and a flat condo market for YVR, which you dismissed as impossible because markets never move sideways after a bubble.

    I expect the condo market to bifurcate in Vancouver too, with the eventual rise in interest rates punishing local buyers and sellers and having truly astoundingly minimal effect on the rich condo hoarders from abroad, and perhaps even the local
    Richie Rich condo hoarders and developers who made out like bandits these 10 years. The sit on a fat cushion of dough and can hang on for a long time.

    Now don’t be coy. We know you’ve called these buyers “mythical” when rumour of them fist started to appear. We know that big foreign money can affect 40 square miles a lot faster than it can a city the size of Los Angeles or Toronto. But, of course, they do have a head start on Toronto. So if you’re thinking of making The Big Move to The Big Smoke, I’d buy in now rather than later. Your wife will like you better for admitting you’re wrong, now.

  8. raw facts says:

    I don’t think the Foreigners will prevent a collapse of 30% but will create one instead. Don’t be fooled by all the media hype, your smarter than that I hope. Why haven’t our foreign investors keep those poor american cities from the continued collapse? They didn’t like Florida, Seattle etc..

  9. Financial Newbie says:

    “There’s never anything wrong with exploring the potential risks to the Canadian economy. This report aligns nicely with my own perspective on Canadian assets. I’m not prepared to sell them yet, but I am watching leading global economic indicators (such as those published by the OECD) and keeping a close eye on China for any indication that a hard landing is shaping up.”

    How much weight do you put in the saying “better to be a month early than an hour too late”? A crash, if it does come, could happen very quickly and you might find it difficult to unwind your positions in the market when most people are looking for exits. While you’re probably not in a position that this would devastate you financially, I still think it would be pretty sad to see a guy who sounds to be very much on the ball get caught up in the very market collapse he predicted because he tried to time it right and take a little bit more off the table rather than cash out when he had the chance…

    Then again, I’m probably just bitter because I cashed out a month ago and could have taken a bit more off the table myself… oh well. Haha.

  10. pascal says:

    Get some silver right now.
    The ride is just beginning!
    Leave the real estate train.
    Jump on board the silver bullet train, its gonna be the ride of your life!
    I hope all family get the message.

    • Severus says:

      Becareful. Silver has a history of slauthering the shleepe and the Johny Come Lately. Exponencial rise and exponencial decline.

  11. mac says:

    Gimme a break You used to say there was no evidence of Chinese buyers. That it was just rumour and there was no data to back it up. You’ve semi changed your tune in recent months. If you want to ban me, ban me. It’s what you do when you hear opinions you disagree with. Ban. Edit. Cut. Mock. Same diff.

    • You were just proven wrong. Read my last comment and note how I actually backed up what I said with some of my own quotes. Try it for a change. It’s refreshing. Good luck finding where I said there is ‘no evidence of Chinese buyers’. My tune hasn’t changed at all. I’m still equally convinced that the HAM story’s greatest effect on house prices is in how it has lured locals into nearly unserviceable debt. That hasn’t changed.

      And not a single one of your comments has been edited or cut. Discredited, yes. But you make that too easy.

  12. Sam says:

    Ben, I’m worried about two things in canada

    1 lower income trust distributions – impact to economy and spending
    2. CRE in canada to me seems to be very close to a tipping point. My team has been scouring Canada’s best business locations and “for lease” signs and incentives are increasing with weaker leases terms. This could be a sign of job losses to come.
    in some cases I’m seeing prime business buildings with 30% empty
    Cheap money and no recourse has been huge in CRE

    Residential real estate stills feels ok, just many many good saving parents helping out the married couple to make that jump into cookie cutter land. If liberals somehow win, we could face a “blame Harper” type crash and fix.

  13. John in Ottawa says:

    While we wait for Ben’s new block buster, we get a little levity from the Vampire Squid, Goldman Sachs.

    It turns out Greece will not restructure its debt. Instead Greece will conduct a “liability management exercise.” It also turns out that sh*t doesn’t stink. It is simply a “transient suboptimal olfactory experience.”

    This is all very good news for Canada. Turns out there will not be a housing crash. At worst we will have a “strategic fundamentals goal seeking exercise.” Mac’s extended flat market will be an “extended divergent economic trajectories hiatus.”

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