Q1 2024: Inflation Watch
In this issue, we discuss cooling inflation, decreasing liquidity in real return bonds (RRB), and why the cost of implementing a U.S. based inflation strategy has increased.
Steve’s take: “Canadian inflation came in soft in Q1 with headline CPI increasing 2.9% year-over-year (figure 1), broadly in line with market consensus and staying within the Bank of Canada’s 1.0%-3.0% target range. Most of the cooling has been coming from core goods, whose prices have been roughly unchanged year-over-year. With evidence of decreasing price pressures, analysts have revived their expectations of the first rate cut of the year occurring in June or July.”
Shelter is currently the main driver of headline inflation with prices increasing 6.5% year-over-year, contributing 1.7% to headline inflation (figure 2). Shelter prices have been a thorn in the side of disinflationary progress.
In addition to core goods, food has been a key contributor to the cooling in headline inflation with only a 3.0% year-over-year increase. This is a significant decrease compared to the 10.4% year-over-year increase seen in January 2023.
Gasoline prices rose 4.5% year-over-year due to crude oil supply concerns amid geopolitical conflict and continued voluntary production cuts.
Figure 1: CPI Change
12-month, YTD, and MoM change in the Statistics Canada Consumer Price Index, monthly, not seasonally adjusted (Table 18-10-0004-01)
Figure 2: Canada headline CPI contribution year-over-year
Bank of Canada Consumer Price Index Portal
Steve’s take: “With decreasing liquidity in real return bonds (RRBs), strong dealer relationships and market experience is a key factor in being aware of opportunities to obtain significant allocations and implementing new RRB mandates at efficient prices.”
Figure 3: RRB trading volume
Bloomberg
RRB trading activity was light in Q1, consistent with trends seen since the Government of Canada’s cessation of RRB issuance in November 2022 (figure 3). Daily trade volume was light over the quarter, with daily trading volume under $60M for all days. With lower liquidity in RRB markets, it may take up to several months to complete the purchase of larger RRB lot sizes at efficient prices.
We continue to monitor entry points for clients who are considering using alternatives to RRBs to hedge Canadian inflation, including U.S. TIPS and inflation swaps. Over the past quarter, the gap between 10-year breakeven inflation rates in the U.S. and Canada widened from 40 bps to 49 bps (figure 4). This suggests that the cost of implementing a U.S. based inflation strategy has increased over the quarter.
Figure 4: US vs. Canadian 10-year breakeven inflation rates
Bloomberg
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CPI change (figure 1)
12-month, YTD, and MoM change in the Statistics Canada Consumer Price Index, monthly, not seasonally adjusted (Table 18-10-0004-01)
Canada headline CPI contribution year-over-year (figure 2)
Bank of Canada Consumer Price Index Portal
RRB trading volume (figure 3)
Bloomberg
US vs. Canadian 10-year breakeven inflation rates (figure 4)
Bloomberg
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