December 2022 market update

Canada Life Investment Management Ltd. - Jan 09, 2023
Global equity markets fell over December 2022 as global banks continued to increase rates, stoking fears of the global economy falling into a recession
December 2022 market update

Introduction

The U.S. Federal Reserve Board (“Fed”), Bank of Canada (“BoC”), Bank of England (“BoE”) and European Central Bank (“ECB”) all raised rates at their final meetings of 2022 in December. The Bank of Japan’s (“BoJ”) policy adjustments suggested it, too, might be keen to start lifting rates. Inflation eased but remained at worrisome levels, while key business activity indicators in U.S. and China showed a slowdown in economic activity.

In Canada, the S&P/TSX Composite Index finished lower, hindered by weakness in the Health Care and Information Technology sectors. In the U.S., the S&P 500 Index also declined, as did the tech-heavy NASDAQ Composite Index. Gold prices moved higher, partly due to rising economic uncertainty. The price of oil finished largely unchanged, as investors considered the price cap on Russian oil, lower supply from OPEC+, and the potential for lower demand if economic conditions weaken. Yields on 10-year government bonds in Canada and the U.S. moved higher over the month.

Getting in one last rate hike 

2022 will likely be remembered for global banks’ aggressive monetary tightening policies toward high inflationary pressures. As many embarked on their final rate decisions of the year in December, they continued to lift rates, with some indicating the pace of those rate hikes might slow in 2023. At its last meeting of the year, the BoC raised its benchmark overnight interest rate by 50 basis points (“bps”) to 4.25%. This was the BoC’s second straight rate increase at 50 bps and seventh straight overall, taking its policy interest rate to the highest level since 2008. While the BoC said it must continue raising interest rates to combat high inflation, comments suggested it might slow the pace of those rate hikes. It was much the same in the U.S., where the Fed raised its federal funds rate by 50 bps to a target range of 4.25%-4.50%, the highest level since 2007. While noting the pace of its interest rate increases could moderate, the Fed expects its policy rate to reach approximately 5.1% in 2023, higher than originally expected.

Meanwhile, at its last meetings of 2022, the ECB raised its key interest rate by 50 bps to 2.50% and the BoE raised its key interest to 3.50% from 3.00%. The ECB and BoE took their policy interest rates to the highest levels since 2008 as they look to ward off inflation despite recessionary concerns. In Japan, the BoJ kept its key interest rate at -0.10% but did adjust its yield curve control program, suggesting it might also raise interest rates in 2023.

Canada’s housing market under strain 

As the BoC continues to raise rates to multi-year highs, mortgage rates have climbed, weighing on Canadian real estate demand. Combined with already elevated prices, which have raised affordability concerns, Canada’s housing market is under immense pressure. According to the Canadian Real Estate Association (“CREA”), sales of existing homes in Canada dropped 3.3% in November. While a lack of demand has been a big contributor to the drop in sales volumes, supply is also a concern. New listings fell 1.3% during November.

Meanwhile, CREA also reported the benchmark home price declined 1.4% in November, the ninth consecutive monthly decline. With overpriced homes and a supply-demand market imbalance, federal, provincial and municipal governments all appear to be focused on raising supply. However, builders seem to be concerned about the real estate market. Building permits have been falling over 2022, suggesting weak confidence among builders amid elevated construction costs and moderating demand. Will high levels of savings and higher wages after the pandemic be enough to offset the higher strain of rising mortgage rates and elevated inflation on Canadian households? 2023 should be an interesting year for Canada’s real estate market and could play a key role in Canada’s overall economic health.

U.S. business activity drops to 2020 levels 

According to the S&P Global U.S. Composite Purchasing Managers Index, business activity in the U.S. contracted for a sixth consecutive month in December. The contraction sharpened during the month and took U.S. business activity to levels close to those at the beginning of the pandemic in 2020. Over the past few months, the U.S. economy has been hindered by a slowdown in the manufacturing and service sectors. Activity has been pulled down largely due to a drop in new orders, including exports. This comes as much higher rates and persistently high inflation weigh on consumers both domestically and abroad. Manufacturing and service sector output has similarly fallen over the past several months. Also providing a backdrop of potential headwinds ahead for U.S. business activity, purchasing managers’ sentiment has dropped to 2020 levels. Despite the U.S. economy’s third-quarter expansion, data suggests a pullback in economic activity in the fourth quarter, which could weigh on overall growth. The Fed noted it’s carefully monitoring economic conditions as it continues to raise rates to slow inflation.

China’s economy under pressure 

China began reducing its COVID-19-restrictions, but a surge in cases of the virus across many parts of the country prompted it to impose substantial lockdown restrictions. The country’s first COVID-19 related deaths since 2020 added to the pressure. Over the entire year, lockdowns had a negative impact on China’s economy, particularly evident in key economic indicators from November. Industrial production, a key component of China’s economy, rose by only 2.2% year-over-year in November, moderating from October’s 5.0% annual increase. Meanwhile, domestic demand has been hindered by lockdown restrictions and uncertain economic conditions. Retail sales dropped by 5.9% year-over-year in November, which marked its sharpest decline since May 2022. China’s property market continues to show little progress, making matters worse by weighing on economic activity. Despite holding its loan prime rates steady at its December fixing, the People’s Bank of China reduced rates during 2022, looking to help boost economic growth in the country. But with lockdown restrictions continuing throughout December, it could be a tough fourth quarter for China’s economic growth.