Bank of Canada Is Way Behind the Curve

BoC policy setting is out of line with economic reality

Highlights

• BoC policy setting is out of line with economic reality

• Small-caps have outperformed the Nasdaq by the most in three decades

• Investors are giddy about a GOP clean sweep

• Generous seasonal adjustment prevented a negative retail sales print

While We Were Sleeping

Well, the only two things that can be said are that the stock market rally continues to show unabated strength and has broadened out in dramatic fashion. All of a sudden, nobody talks about the Magnificent Seven any longer. That group was mixed, with Nvidia the biggest loser (-1.6%).

Small caps, the Dow, and several non-Tech sectors have been leading the way this past week — Homebuilders, Financials, Industrials, Medical Care and Infrastructure plays have been blazing the trail. The small-cap Russell 2000 jumped +3.5% yesterday to a fresh multiyear high; the S&P Mid-Cap 400 index popped +2.5% to a record high; and the S&P 500 Equal Weight index rallied +1.8% to a record high. The Dow (+1.85%) had its best day since June 2023. The S&P 500 lagged behind at +0.6% but still made a new high by a slight margin.

The 10-year Treasury yield fell six basis points to 4.17%, testing four-month lows as futures are almost fully priced for a Fed rate cut in September and sniffing out three moves through year-end. A flat DXY dollar index coincided with a +0.9% pop in the gold price to a new all-time high of $2,483 per ounce. Only the oil price failed to join in on this “everything rally,” sliding -1.4% to $80.76 per barrel and is off for three straight sessions on the back of economic weakness out of China, softening crack spreads (refining margins) and signs of compliance issues within OPEC+. This took the Bloomberg commodity index lower for three consecutive days as well, and to the lowest level since the end of February. One reason why this sudden shift to “value” and “small caps” is so bizarre — usually, the commodity complex is part and parcel of these market moves which traditionally symbolize a pro-cyclical thrust. Not this time.

Indeed, the Russell 2000 (+10.3%) has outperformed the Nasdaq (-0.7%) by +11.1 percentage points over the past four sessions. This is the biggest performance gap between the two on record based on data back to 1990. The +742-point surge in the Dow and this general shift to value is interesting too, because it has a 40% positive correlation to bond yields and a 70% positive correlation to inflation — yet rates and the CPI trend are heading in the other direction! I had a contact email me yesterday to tell me this is all part and parcel of the 18.6-year cycle! Investing has become this sophisticated. Who needs a CFA designation for today’s capital markets? Colossal waste of time and money (and anxiety).

It appears that investor “animal spirits,” especially in the value trade, have taken on a whole new head of steam because of this growing feeling that Donald Trump is going to emerge victorious on November 5th, and the odds are rising that the GOP will enjoy a clean sweep. If that happens, goodbye 21% corporate income tax rate and hello 15% (light years from 35% pre-2018). It hasn’t been there since 1937!

No wonder investors are foaming at the mouth. Ronald Reagan received a boost as well after his assassination attempt, but that was in 1981, three years before the next election. This one is less than four months away. And there are signs that this could be a landslide of Reagan-like proportions. This is why Bitcoin has been surging too — because of the belief that Trump will be a regulatory chum in the crypto space (especially his VP pick) — he wants it “made in the USA!” The speculative fervor is something to behold.

The fact that Trump weighed in on the Fed in his June Bloomberg interview and warned the central bank not to cut rates ahead of the election points to a future of meddling in monetary policy (and stating that he will allow Jay Powell to serve out his term — this is a shift — but only if the Fed Chairman does the “right thing…” now you know why Teddy Roosevelt coined the term “bully pulpit” in reference to the Oval Office).

I imagine what Donald Trump would really like would be a steady diet of rate cuts after the election but interference with Fed policy, as we saw in his last term, is bullish for bullion… no wonder gold surged along with everything else yesterday. What doesn’t fit in this “no landing” scenario that the risk-on trade has bought into is this impressive rally we are seeing in the Treasury market… now what could that economic message possibly be? The issue at hand is that the futures market does not believe for a second that Powell will heed that Trump message, with investor-based odds of a September rate cut jumping to 97% from 73% a week ago (have a look at Search for Safety Buoys Treasurys on page B1 of today’s WSJ).

But let’s compare today’s landscape to what things looked like back in November 2016, when investors went wild on a future of fiscal goodies… thing is, the stock market was in a far less extreme condition compared to today: