Weekly Market Update (December 4 – December 8, 2017)

By Craig Fehr December 08, 2017

Stocks were marginally higher on the week as investors continued to process the potential impact of U.S. tax reform and political developments out of Washington, D.C. From an economic perspective, both the Canadian and U.S. labour markets strengthened in November. U.S. average hourly earnings grew 2.5% over the past year, accelerating from the 2.3% growth reported in last month's report. Modest but rising wages should support household spending, in turn powering the economy forward at a moderate pace. November's jobs report is unlikely to materially alter the U.S. Federal Reserve's monetary policy approach of gradually raising interest rates (including a rate hike next week) and slowly reducing its balance sheet. Overall, inflation has rebounded from lows experienced midyear and labour market conditions remain quite healthy, reflecting the solid fundamental backdrop that has supported the bull market in stocks.

The BoC Takes a Break: 4 Key Implications

After two consecutive rate hikes in the fall, the Bank of Canada held its benchmark interest rate steady last week, consistent with our expectations. In its policy statement, the BoC noted:

  • The benchmark rate remained at 1.00%, having raised it this year from 0.50%, where it had been since 2015.
  • Higher rates will be "required over time"; but that is taking a more cautious approach as current monetary policy "remains appropriate."
  • Employment conditions have improved, but further slack remains in the labour market.
  • Canadian economic growth is anticipated to remain above potential over the balance of 2017.
  • Core inflation has picked up in response to less economic slack, but the recent lift in headline inflation reflects temporary factors, including a rise in gasoline prices.

Over the past several months, consensus expectations had indicated that another rate hike this month was possible; however, we view the BoC's move to hold rates steady as the appropriate policy response. We maintain our view that the domestic economy will cool moving into and through 2018. Therefore, particularly with inflation still muted, it would be prudent for the Bank of Canada to evaluate the impact of this year's rate hikes and shifts in the domestic and global economic landscape before tightening policy further.

We think the central bank's policy stance has the following implications:

  • Canadian economy: While the 4% pace of GDP growth in the first half of this year was encouraging, we don't think it will be sustained. Instead, we think economic imbalances will drive growth toward the 1.5%-2% level in the coming year. The BoC's 0.50% increase in rates this year won't slam on the breaks, but we think high consumer debt and a cooling housing market will curb household consumption (the largest contributor to GDP). Further rate hikes will likely amplify the headwinds to consumers, supporting our view that the BoC is prudent to take a pause on further policy tightening. Elsewhere in the economy, business investment is in need of a lift, but it will likely be more sensitive to the outlook for oil prices and foreign demand than to short-term interest rate changes. To that end, the latest rebound in exports bodes well, but signals more about improving U.S. economic growth. Conversely, Canadian imports dropped recently, signaling some weakness in domestic demand.

  • Stock market: In our view, the 21% gain in the TSX in 2016 reflected the rebound in oil prices and the anticipated boost in Canadian economic growth. Domestic stocks have delivered a decent 7% return this year, but have notably underperformed international equities. Still-low interest rates help support the compelling story for stocks, a relative relationship that is not under immediate threat from BoC policy. More influential is the composition of the TSX, with three sectors (financials, energy, and materials) comprising 66% of the index. Year-to-date weakness in the energy and materials sectors has been the primary drag. As for the financial services sector (35% of the TSX), the pause in rate hikes may offer an extension of help to consumer finances and housing affordability, benefiting the banks. That said, we don't think this eliminates the headwinds financials face from consumer indebtedness and slower loan demand/housing investment. More broadly, the BoC's latest decision reflects the headwinds facing Canada's economy, which, along with the TSX's sector concentrations, will drive positive but muted gains for the domestic stock market, in our view.

  • Interest rates: We expect the Bank of Canada to remain on hold well into 2018. Slower economic growth and range-bound oil prices are likely to keep inflation below the BoC's target, necessitating an extension of current monetary policy settings. Looking ahead, we expect longer-term interest rates to remain fairly low by historical standards, but to rise slowly as the economic expansion is sustained. In terms of an alternative to this outlook, if labour market slack continues to reduce in a manner that pushes wage growth higher, inflation pressures could firm, prompting the BoC to implement additional rate hikes in 2018, leading longer-term rates higher as well.

  • Canadian dollar: As the July and September rate hikes led a surge in the Canadian dollar, we maintained our view that the loonie's jump to US$0.83 was overdone, reflecting overly optimistic expectations for ongoing domestic growth and additional BoC rate hikes. As the Bank of Canada pauses to observe how the domestic economy absorbs recent rate increases along with progressing economic conditions at home, in the U.S. and abroad, we think this will exert some restraint on the loonie, particularly as the U.S. Fed looks to raise rates in the coming year. An additional wildcard is the NAFTA negotiations. While we don't expect a complete scrapping of the deal, Canadian-U.S. trade could be adversely impacted by a rising C$, making an additional case for Canada's central bank policy to avoid exerting upward pressure on the loonie (by way of rate hikes).

The Stock & Bond Market

Index Close Week YTD
TSX 16,096 0.4% 5.3%
S&P 500 Index 2,652 0.4% 18.4%
MSCI EAFE* 2,005 0.1% 19.1%
10-yr GoC Yield


-0.05% 0.14%
Oil ($/bbl) $57.31


Canadian US $0.78 -1.4% 4.5%

Source: Bloomberg. *5-day performance ending Friday; Past performance does not guarantee future results.

The Week Ahead

Macroeconomic reports and ongoing news flow regarding U.S. tax reform will be the focus for investors next week. From a Canadian perspective, existing home sales will be reported on Friday. South of the border, the U.S. Federal Reserve's interest rate decision will come Wednesday afternoon.

Important Information

The Weekly Market Update is published every Friday.

Edward Jones does not provide access to past weekly summaries.

The S&P/TSX Composite Index and S&P 500 Index are unmanaged indices and cannot be invested into directly.
Diversification does not guarantee a profit or protect against loss
Dividends may be increased, decreased or eliminated at any time without notice.

Investors should understand the risks involved of owning investments, including interest rate risk, credit risk and market risk.

Special risks are inherent to international investing, including those related to currency fluctuations and foreign political and economic events.

The value of investments fluctuates and investors can lose some or all of their principal.

The content of this report is for informational purposes only and should not be interpreted as specific investment advice. Investors should make investment decisions based on their unique investment objectives and financial situation. While the information is believed to be accurate, it is not guaranteed and is subject to change without notice.

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Diversification does not guarantee a profit or protect against loss.

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