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 Morris, CFA
Steve’s take: "Canadian inflation cooled in Q2 with year-over-year headline CPI decelerating to 2.7% (figure 1), 0.1% below market consensus. The average of the Bank of Canada’s two core inflation measures remained steady at 2.7%. With apparent easing of price pressures, the odds appear favourable for further central bank rate cuts.”
Gasoline price growth softened to 0.4% year-over-year, largely contributing to the deceleration in headline CPI.
Shelter remains the main driver of year-over-year inflation with prices increasing 6.2%, contributing 1.8% to headline inflation (figure 2). Excluding shelter, the year-over-year increase in CPI is 1.3%, Within shelter, rented accommodation continues to run hot at 8.5% year over year while owned accommodation has stabilized at around 6% year over year as mortgage interest costs have decelerated somewhat and insurance and property taxes have been elevated.
Food prices are also a key driver of year-over-year inflation, with prices increasing 2.8%, contributing 0.5% to headline inflation.
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.”
RRB trading activity was light in Q2, consistent with trends seen since the Government of Canada’s cessation of RRB issuance in November 2022 (figure 3). Daily trading volume was under $50M for all days except for June 27, where $68M of trading volume was observed. 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 slightly narrowed from 49 basis points (bps) to 47 bps (figure 4). This suggests that the cost of implementing a U.S. based inflation strategy has decreased over the quarter.
Figure 3: RRB trading volume
Bloomberg
Figure 4: US vs. Canadian 10-year breakeven inflation rates
Bank of Canada Consumer Price Index Portal
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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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