Inflation concerns eased, while AI’s star began to wane

• June inflation in Canada was lower than expected: rate cuts expected.
• The stock market saw a massive rotation from big tech to smaller companies.
• The semiconductor industry was hit hard, with AI trade under scrutiny.

Inflation in Canada surprised for June, coming in lower than expected and mirroring the dip we saw in the U.S. This easing continued, albeit at a slower pace than before. Shelter costs remained the biggest contributor to inflation, sitting at 6.2% year-over-year, largely due to rising mortgage interest rates. Looking ahead, we anticipate inflation to hover between 2% and 3% over the next six months, comfortably within the Bank of Canada’s (BoC) target range of 2% +/- 1%. It’s therefore likely that the BoC will announce a second rate cut next week.

With inflation concerns starting to settle, the BoC will need to shift its focus. While it’s made significant progress in controlling inflation, the economic landscape is evolving. The job market, for instance, is in rough shape. The latest employment report was disappointing, showing an uptick in the unemployment rate, which is now 1.6% higher than at the low point in July 2022. We’re seeing a shift from full-time to part-time jobs, and the overall quality of employment is weakening. Canadians are feeling the pinch from a mix of high mortgage rates, lingering inflation effects and a shaky job market. The BoC can’t just tackle one issue at a time anymore. It needs to balance the risks of high interest rates against not only inflation but also the broader Canadian economy. It’s therefore likely that the BoC will focus more on economic growth and continue with rate cuts, with the next one expected next week, and possibly two more in the fall.

This week’s stand-out story is the massive rotation in the stock market. Investors have been selling off the big tech giants in favour of smaller companies, at a pace that we haven’t seen since the early 2000s. The Equal-Weighted S&P 500 surged and many popular stocks have taken a significant hit. The drop in AI stocks is the largest we've seen since March 2021, and the decline in AI semiconductor stocks is unprecedented since the index’s inception. Similarly, the plunge in the so-called "Magnificent Seven" tech stocks (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla) is the steepest since November 2022. On the flip side, we've seen notable gains in sectors like housing, regional banks, unprofitable tech companies, lending-sensitive stocks and commercial real estate (areas that were previously out of favour). It’s hard to pinpoint a single cause, but it seems like various factors are playing a part: Trump’s recent comments on technology exports; fears of protectionism with the vice-president nomination of Ohio Senator J.D. Vance; easing inflation concerns; and shifting rate expectations.

The semiconductor industry had a rough week, especially after semiconductor supplier ASML’s disappointing results. However, Taiwan Semiconductors helped stabilize things with strong results of its own. Its revenue from the most advanced chips rose 28% from the previous quarter. Even with this bounce, the recovery wasn’t as strong as you might have expected, given the earlier drop. The scrutiny on AI investments will continue to grow.

Listen to this week’s podcast for further insights.