Most asset classes exhibited strength through July, with the exception being the TSX. Since the calendar year peak on 21-Feb-17, the Canadian equity benchmark has shed 5% (as at 24-Jul-17). The recent weakness is surprising considering that oil (+9.4%), gold (+0.7%) and the Bloomberg Commodity Index (+4.5%) have been climbing in July. Similarly, the S&P 500 and MSCI World equity indices have posted gains of 1.5% and 1.3%, respectively, during the measurement period. Earnings have been driving US and overseas markets. As of the date of this memo, 19% of S&P 500 companies have reported second quarter results, with 73% beating mean EPS estimates. On the oil front, generally positive fundamental inventory data has guided consecutive monthly gains, though US dollar weakness is a contributing factor. US 10-year Treasury Bond yields resumed an upward trajectory, rising 16bps to 2.30%. Since breaking above 2% in November following Trump’s election win, the yield drifted as high as 2.62% (March 2017) and touched 2.14% in June 2017. A falling 10-year yield can be attributed to slowing economic growth and anemic inflation expectations. When confidence is high, the 10-year yield typically rises.
The US Dollar continues to weaken as the DXY, which measures the USD against a basket of developed market currencies, has dropped 7.9% from 01-Jan-17 to 25-Jul-17. From Europe to Japan, and even Canada, it is becoming evident that a coordinated policy of tightening may be on the horizon. Accordingly, investors have shifted their views and positioning with respect to global currencies. This is particularly evident with the Canadian Dollar which has soared over 9% from May to July. A speech from Bank of Canada deputy Carolyn Wilkins first tipped the market of the potential for tightening. The suggestion was confirmed on 12-Jul-17 as Governor Stephen Poloz hiked rates in Canada for the first time in 7 years to 0.75%, while paving the path for further hikes based on solid GDP and employment growth. Canada’s GDP has been reinforced by an overheated housing market. Debt has been extended as home values have appreciated – Canada’s economic dependence on leverage has never been so evident. Higher borrowing costs will certainly cause a slowdown in housing. While increasing interest rates may boost the Canadian dollar further. A rising exchange rate has negative consequences for Canadian exporters. Clearly, Mr. Poloz will find himself in a precarious position with respect to future hikes.
Two US themes that we have highlighted in past reports seem to be headed for a collision in September – The Healthcare Repeal and The Debt Ceiling. Following numerous impasses, the GOP has finally voted to debate the potential repeal and replacement of Obamacare. On the debt ceiling front, the Congressional Budget Office estimates that a decision is needed by October as the limit will be attained at that point. With dysfunction ruling in Washington and dissention within the Republicans, traders are already expressing their anxiety regarding the potential for US default. Yields on 3-month Treasury Bills are now higher than those for a 6-month term, reflecting payment uncertainty should the US be unable to extend its debt ceiling.