Default and Credit-Loss Cycle in Canada Clips the Loonie’s Wings

Canadian economy is in trouble as interest rates begin to bite

Highlights

• Canadian economy is in trouble as interest rates begin to bite

• Anchored inflation expectations are bullish for bonds

• The math doesn’t add up behind the sentiment-driven equity market

• Credit fundamentals sour as spreads hit multi-decade lows

While We Were Sleeping

U.S. markets are closed for Memorial Day, but it was risk-on for everybody else. European markets are eking out a near +0.2% advance and Asia rocked and rolled today: Korea (+1.2%), Hong Kong (+1.2%), China’s Shanghai Composite (+1.1%), Taiwan (+1.1%), Japan’s Nikkei 225 (+0.7%) and India (+0.7%).

All in, the MSCI Asia-Pacific index bounced +1% today and the EM complex is on pace to close at +0.8%. Bond markets are quiet (Treasuries on pace for a +1.4% total return for the month), as is the FX market, with the DXY dollar index stable at 104.7 — dollar-yen receded -0.2% to ¥156.7 as the BoJ hinted that its fight with deflation has ended and further policy normalization will be coming our way over time (good news for the yen as well as for Japanese financials). Brent crude is up a modest +0.1% here in the early going to $82.20 per barrel; gold has mustered a +0.3% uptick to just over $2,340 per ounce; while Bitcoin has retreated -0.4% to $68,440 (all market quotes are time-stamped to 4:00 a.m. ET).

The data docket was sparse — only the German ifo business sentiment survey was released overnight, and disappointed by coming in flat in May at 89.3 (consensus was 90.4) — the key “expectations” segment managed to improve to 90.4 from a downwardly revised 89.7 in April (was 89.9) and this also missed consensus views expecting a 90.8 reading. This ends a nice run, of late, in the economic numbers handily beating market forecasts.

There is much talk about how this has been an “earnings driven” equity market rally. But that is not the case, one iota. It is purely multiple expansion driven — the S&P 500 P/E ratio has jumped from 17.5x last October to 20.8x currently. It is difficult to pinpoint the reason for this heightened level of confidence since interest rates have not exactly provided any tailwind at all. What we do know with any degree of certainty is that we are at peak multiples, peak sentiment and peak positioning — with the May global fund manager survey published by Bank of America showing institutional investors having their highest equity allocation since January 2022 (that exposure proved to be a wonderful contrary indicator for much of the rest of that year).

A Harris Poll conducted for the Guardian finds that 56% of Americans believe a recession has already begun. That may not be showing up in the data just yet, but remember that the initial releases of the government-published numbers typically have a small sample size and are subject to revisions, and practically every indicator this past month has shown these to be downward, not upward. What is important is that the growth in available supply is outstripping that of aggregate demand — disinflationary irrespective of what the flawed CPI metric has been flagging — and this is underscored by the fact that the Census Bureau’s index of economic activity has shown the U.S. economy expanding below-trend every month so far this year.