U.S. Fed Chair Jerome Powell made several interesting comments during his interview last weekend on the CBS show 60 Minutes interview. He notably said parts of the economy that involve people being in the same place will be challenged until people feel really safe again. Several surveys show consumer anxiety about the virus will last until a vaccine is found, making it difficult to imagine significant upward inflationary pressures over the next 12-18 months.
Credit growth, another ingredient typically fuelling CPI inflation, is also missing out. Statistics from the U.S. Consumer Financial Protection Bureau reveal a 25% to 50% decline in mortgage, credit cards and auto loans inquiries during the month of March alone. In addition, half of the respondents to a Cleveland Fed survey reported fears of losing their job as of mid-April. The same survey reveals 40% of Americans had increased savings. The situation is likely similar for Canadians. Overall, individuals are not in the mood for discretionary spending/credit because of pandemic fear, the severe deterioration in labour market conditions and weak expectations about the future. Thus, market participants thinking that central banks balance sheets expansion will ignite CPI inflation should reconsider their view.
Instead, this poor economic backdrop is favourable for a rapid cooling in CPI inflation in the short term. Statistics Canada will release the CPI report for April on Wednesday morning. Our detailed bottom-up analysis model leads us to forecast a 0.6% m/m nsa drop for the headline number, in line with consensus at -0.6%. The drop in CPI for Canada resembles the -0.7% m/m nsa U.S. print published on May 12 by the Bureau of Labor Statistics. Our estimate is notably driven by a plunge in clothing (-4%) and gasoline prices (-13%).
In the U.S., food prices increased at a pace unseen since the 1970s. In Canada, we expect a 0.7% m/m jump in the Canadian food CPI component, which is very high for the month of April. There are a few isolated signs of FX pass-through, such as on imported components, particularly household furnishings and equipment (+2% cumulative in February and March). In the grand scheme of things, the weaker Canadian dollar does not appear to be a big factor enough to say Canadian CPI inflation will be materially higher than U.S. CPI inflation or that RRBs should be favor over U.S. TIPS.
Investors should also note the elevated degree of uncertainty in CPI releases because of the difficulty to collect data during the COVID-19 pandemic. For instance, the U.S. Bureau of Labor Statistics was unable to collet 34% of goods and services prices in April because several stores were closed. If our call is right, Canadian total CPI will drop to -0.2% on a y/y basis, dipping into negative territory for the first time since June 2009. Under our best-case scenario, the annual CPI inflation rate will remain slightly below zero for two additional months before slowly increasing near 1% in 2020 Q4, which could create interest in RRBs sooner rather than later.
Finally, the progressive reopening of the economy, the surge in crude oil prices observed so far in May and central banks expressing zero tolerance for CPI deflation should prevent markets from pricing the beginning of a long deflationary spiral.