Friday, 23 March 2018

Over the top

"Things should start getting interesting right about now". (Bob Dylan, "Mississippi")

Things are certainly about to get interesting for the Bank of Canada and its Governor, Stephen Poloz.  Statistics Canada just reported that headline inflation rose to 2.2 percent year-on-year in February, the first time it has moved above the 3 percent target since 2014.  All eight major components of the index have risen over the past year, but the biggest culprit has been the price of gasoline, up more than 12 percent on a year-over-year basis.  CPI ex gasoline is up a slightly less threatening 1.8 percent.

There's more.  The Bank's famously obscure "preferred measures" of inflation have been edging up towards 2 percent for several months now. In February two of the three indices (CPI-median and CPI-trim) edged above the target, with both standing at 2.1 percent.  If these really are the key indicators the Bank looks at when it makes its policy decisions, then it is hard to see how additional tightening measures can be delayed for very long.

There is little reason to think that the gradual rise in year-on-year inflation will stall any time soon.  The Bank has been warning for almost a year now that the economy is operating close to full capacity, which must inevitably translate into cost and price pressures at some point.  The protectionist measures that now seem to be coming out of Washington on almost a daily basis will inevitably create price pressures south of the border, but because of the close integration of the two economies, those pressures will also spill over into Canada.  Lastly, the Canadian dollar seems to be on shaky ground, and any further weakness in the exchange rate would add further to upward pressure on Canadian prices, not least for gasoline.

Governor Poloz has been preaching caution about the rate outlook, even musing at one point that there might be no further action by the Bank this year.  Moreover, the Bank's increasingly prominent Senior Deputy Governor, Carolyn Wilkins, has recently spoken of work "still to be done" to ensure financial system stability.  Given the high debt level of Canadian households, rapid rate increases by the Bank could start to put that stability at risk.  Still, if it wants to maintain the credibility of its inflation target -- which it surely must -- the Bank will not be able to ignore the upward trend in CPI for very long.  Best guess: one 25 bp rate hike by mid-year and another in the second half.

Wednesday, 21 March 2018

Fed signals higher path for rates

As expected, the Jerome Powell era at the US Federal Reserve began with a 25 basis point rate hike, bringing the target range to 1.5 - 1.75 percent, a level at which the Fed considers that its policy stance "remains accommodative".

The FOMC press release says nothing very new.  Rates will continue to increase gradually, but the actual pace will as usual be determined by the data flow, and rates will "remain, for some time, below levels that are expected to prevail in the longer run".  However, the economic projections released at the same time suggest that the eventual extent of policy tightening may turn out to be greater than has been assumed until now.

To summarize: GDP growth forecasts for 2018 and 2019 have been increased marginally from the projections released in December, to 2.7 and 2.4 percent respectively.  Growth is expected to slow to 2.0 percent in 2020, but this means that growth in all three years will be above the Fed's longer-run expectation of 1.8 percent.  In a similar vein, projections for the unemployment rate have been revised lower, with the rate sinking to a remarkable 3.6 percent by 2020, well below the longer run projection of 4.5 percent.

Inflation (measured using the personal consumption expenditure deflator) is projected to edge just above the Fed's 2 percent goal by 2020, but needless to say, any faster or sharper increase would trigger a Fed response. As things stand, the median projection for the funds rate for 2020 is now 3.4 percent, 30 basis points higher than was foreseen in December.

Prior to today's release, market expectations had been that the FOMC would raise its target three times this year, including today's move.  The adjustments to the outlook for 2018 do not, in themselves, point to a need for a faster pace of tightening in the near term.  The Fed's own projections now suggest a further three 25 basis point hikes will follow in 2019, up from two such increases projected earlier.  However, if the Fed observes that the tightening labour market is exerting upward pressure on wages and inflation, the pace could be moderately faster.

One striking feature of both the press release and the data is the absence of any identifiable impact from the major tax cuts recently enacted by Congress.  However, there is no doubt that monetary and fiscal policy are now pulling in opposite directions.  Cutting taxes at a time when the economy is already operating at or near full capacity is a risky policy, one that can only make the Fed's future decisions that much more difficult.   

Friday, 16 March 2018

Assets, liabilities and cashflow

Rejoicing in the land, or at least in the business pages, at the news that the seemingly inexorable rise in Canadian household debt may have halted.  StatsCan reported on Thursday that the ratio of household debt to disposable income edged down from 170.5 percent in Q3/2017 to 170.4 percent in Q4.  Moreover, the Q3 number was itself revised lower from an initially-reported figure of 171.1 percent, an all-time high.  The dollar value of household debt rose by about 5 percent in 2017, with both mortgage and non-mortgage debt rising at approximately the same pace.

There is other good news in the survey, if that's what you are inclined to look for.  Household net worth rose 2.1 percent in Q4, led by gains in the value of financial assets, which account for about 60 percent of total wealth.  In contrast,  the value of the national housing stock rose only marginally in the reporting period as major markets, notably the Toronto area, pulled back in response to government measures to cool things down.

The asset side of the balance sheet bears closer scrutiny.  Note that the data are for the final quarter of last year, when the nine-year equity bull market was still going strong.  Although it may be too soon to call an end to that bull run (the second longest on record), market action in the current quarter  suggests that further significant gains in the value of financial assets will be harder to come by.

Then there's the housing component. The Canadian Real Estate Association just reported that the average price of a Canadian home fell by 5 percent in the year to February.  Prices in the Toronto region have fallen much more sharply, by more than 12 percent over the same period.  Despite the usual whistling past the graveyard on the part of realtors, there is little prospect of any near-term rebound. 

Then there is the cashflow question. Despite the apparent signs of leveling-off in the second half of 2017, the debt-to-income ratio is at a record high.  Canada stands almost alone among major economies in not reducing the debt burden in response to the global financial crisis.  Something like 20 percent of all outstanding mortgages come up for renegotiation in the next twelve months, inevitably at higher rates, so the burden on disposable cashflow will increase.  This is not to suggest that households are about to default in droves, but the problems facing the rising number of highly-indebted households will only get worse.

The bottom line here is that in 2017 household debt increased by about $5 billion, while national net worth lagged slightly with a gain of just more than 4 percent for the year as a whole.  But while debts are intractable and fixed, asset values fluctuate, sometimes violently.  It is reasonable to surmise that while the value of household debt at the end of the current quarter will be little changed from the end of 2017, net worth will have shrunk, as a result of the pullback in house prices and the headwinds facing financial markets.  In short, yesterday's data from StatsCan are good news, but it is way too soon to suggest that the risks posed by household indebtedness are on the wane. 

Thursday, 15 March 2018

Cut Trump a little slack. Really!

Donald Trump is admitting, or rather boasting, that when he accused Canada of running a huge trade surplus with the US, he was basically making it up.  Who would ever have guessed he would be capable of such a thing?

In his latest tweet on the subject earlier today, Trump made the same claim.  Commentators on CNN were aghast at his playing fast and loose with the facts.  As they correctly pointed out, Canada has a surplus in goods trade with the US, but that is dwarfed by the very large surplus that the US enjoys in trade in services, so the overall trade balance favours the US.

Here's where I think the commentators are failing to connect the dots.  Trump's voter base, to which his every tweet and speech is directed, is largely made up of the likes of steelworkers in Pennsylvania,  coal miners in West Virginia, dairy farmers in Wisconsin: producers of goods.  His base is largely devoid of service workers such as Wall Street bankers, or Hollywood entertainment types, or Massachusetts insurance agents. 

In the types of products that keep bread on the tables of Trump's base -- goods -- the US is indeed running a deficit.  That's the only trade they care about, so that's what he talks about.  It's nowhere close to the whole picture, but it's not exactly wrong, either. 

Sunday, 11 March 2018

We've seen how this movie ends

Does any of this sound familiar?

On one side, a businessman who inherited serious money from his father, with minimal political experience, embracing a right-wing populist policy agenda and vowing to clean up a "corrupt"  government.

On the other, a woman with a lifetime of political experience in increasingly senior roles, embracing a moderately progressive policy agenda, but seen for better or worse as very much part of the political establishment.

Donald Trump and Hillary Clinton?  Well, yes, but as of last evening that's also what we have here in Ontario.  After a thoroughly chaotic selection process, the Progressive Conservative Party chose  Doug Ford to lead the party into June's election against incumbent Premier Kathleen Wynne of the Liberal Party.

Beset by dubious dealings and incompetence, and burdened by the fact that the electorate may simply be tired of the Liberals after more than a decade in power, Wynne saw her approval ratings sink to unprecedented levels last year -- scarcely more than 10 percent of voters gave her a positive mark at one point.  She has responded with a blizzard of progressive policy measures, not least a big hike in the Provincial minimum wage, which seems to have turned things around a little.  Still, she remains personally unpopular: her party might well fare better with another leader.

As for the PC party, the last two months have been a giant dumpster fire.  The party's creepy leader, Patrick Brown, was accused of sexual harassment.  He resigned.  The party looked set to appoint a new leader without consulting the membership, given the imminence of the election, but Doug Ford (brother of the late Rob, erstwhile Mayor of Toronto) threw his hat into the ring, so a formal ballot was hastily set up.  Three female candidates (including Caroline Mulroney, daughter of a former Prime Minister of Canada) also declared their candidacy.

And then, so did Patrick Brown, declaring himself "fully vindicated" of the sexual harassment charges, despite zero evidence to that effect.  And then Brown dropped out again.  And then there were problems with the complex system set up to select the new leader, with many party members claiming to have been disenfranchised.  And then, this past Saturday, the announcement of the winner at a special party convention had to be repeatedly delayed because of a dispute between two of the candidates.  Only after all the poor saps who had paid $50 to attend the convention had been sent home was the party finally able to announce Ford as the winner.  The second place finisher, Christine Elliott, initially cried foul and threatened to take the whole matter to court, but has since conceded defeat.

These people couldn't organize a two-car funeral, but pundits are already warning that come election day, you can't rule Ford out.  This is, after all, the age of populism, and Doug Ford fits the bill perfectly.  His ambitions have never been hidden, and you have to think he has figured out that this is his moment.

Look at it this way.  Ford (Trump) only entered the race because he perceived that his opponent Wynne (Clinton) is irredeemably unpopular with the electorate.  She is the only opponent he could possibly hope to beat.  With much of her party's platform well-received by the voters, the unpopular Wynne (Clinton) is probably the only leader who could possibly fail to defeat Ford (Trump).

Scary, no?  Rural ridings across much of Ontario vote Tory regardless of who the leader or local candidate is, and "Ford Nation" in Toronto will stand by its man.  Will that be enough?  It's going to be close. 

Friday, 9 March 2018

Clear as mud

StatsCan reported this morning that employment rose 15,000 in February, nudging the national unemployment rate down to 5.8 percent.  Coming after the surprising 88,000 decline in employment in January, the small rebound is at least somewhat reassuring.  However, any hope that the February numbers would clarify whether January's data were the start of a new trend or merely an anomaly has largely been dashed.

The overall rise in employment resulted from a 55,000 rise in part-time work (after a decline of 144,000 in January) offset by a 39,000 decline in full-time employment (after a gain of almost 50,000 in January).  The perennially volatile self employment component of the survey showed a decline of 43,000 positions in February.

On the surface, the February data seem to represent a departure from one of the key positive trends in Canadian employment over the past year, namely, growth in full time employment at the expense of part-time positions.  StatsCan notes that employment in February stood 283,000 higher than in the same month of 2017, with all of the gains coming from full-time employment.  However, given that full-time employment continued to rise in January even as overall employment plummetted, it is too soon to draw any real conclusions from this.

One interpretation of the January data that can probably now be discounted is the notion that the Ontario minimum wage hike was the primary culprit for the job losses. This viewpoint, it should be said, was voiced loudest by politicians and newspaper columnists rather than economists. It was never very credible, given that part-time employment fell right across the country in January, not just in Ontario.  In any case, the sold rebound in part-time employment in February surely means that we have to look elsewhere for an explanation of the January numbers.

Incidentally, data for my own region of Niagara help give the lie to the notion that the minimum wage hike had an early negative impact. The region used to be the heart of Canada's metal-bashing industries, but those have been decimated in the past two decades, mainly as a result of free trade.  Those jobs have been largely replaced by jobs in tourism and call centres, in both cases heavily skewed towards minimum wage and part-time employment.  And yet, remarkably, the unemployment rate in the region has fallen in each of the past two months, and now stands well below the national and Provincial rates, at 5.2 percent.

Where does all this leave us, and more important, where does it leave the policy-makers at the Bank of Canada?  It is still reasonable to believe that the economy is operating close to full capacity, which means further monetary tightening is still in prospect.  However, a slight fall in year-over-year wage gains (to 3.1 percent in February from 3.3 percent in January) may give the Bank a little more room for maneuver.  Then again, fiscal policy at the Federal level is still very stimulative, and now Ontario has announced that its budget, to be tabled at the end of the month, will also feature a return to deficit spending.  Governor Stephen Poloz never tires of repeating that the Bank's policy course will be data-dependent, but he must surely wish that the data were a lot clearer than today's turned out to be. 

Wednesday, 7 March 2018

Economy softer = Bank's job harder

In line with market expectations, the Bank of Canada left its target rate unchanged at 1.25 percent after today's Governing Council meeting.  The post-meeting press release highlights three areas of uncertainty in the near-term outlook: GDP growth, US trade policy and the housing market.  Let's look at these in turn.

First, growth.  The press release notes that Canadian GDP grew by 3 percent in 2017, and mentions in passing that the economy is "operating near capacity".  However, the pace of growth slowed markedly in the second half of last year, averaging just slightly above 1.5 percent in Q3 and Q4.  Data for Q1/2018 are still patchy, but the sharp decline in part-time employment in January will certainly have caught the Bank's attention. 

Was this (a) just another example of the volatility of the sub-components in the Labour Force Survey, and thus likely to reverse or at least even out over time; (b) a one-off adjustment to the leap in Ontario's minimum wage at the start of the year; or (c) a harbinger of a much softer trend in the jobs market, keeping in mind that employment is usually seen as a lagging indicator of economic activity?  Data for February will be released this coming Friday, and should provide greater certainty over the near-term direction of the jobs market.

Second, trade policy.  Uncertainty over the fate of NAFTA has been weighing on sentiment (and on the exchange rate) for some time, and now President Trump has threatened to impose tariffs on US imports of steel and aluminum, both key products for Canada.  Canadian Foreign Minister Chrystia Freeland initially made the ludicrous suggestion that NAFTA and steel tariffs were separate issues, but it is crystal clear that Trump is using the tariff threat to put pressure on the NAFTA negotiations. 

Canada is directly in the firing line as far as steel and aluminum are concerned -- the ostensible target, China, is not a big player in either, at least as far as trade with the US is concerned -- but a wide range of countries are threatening retaliation if the US goes ahead. Comparisons with the disastrous effects of the Smoot-Hawley Tariff Act in the 1930s may be overwrought, but any significant slowing in global trade would have a noticeable impact on Canada's own growth, and hence on the Bank's rate decisions.

Lastly, housing. The Toronto real estate market took a dive in February, both in terms of prices and completed sales.  It's striking to see that the Toronto Real Estate Board, in a desperate attempt to put a brave face on things, is resorting to comparing prices to those of two years ago, playing down the usual year-on-year comparisons.  The Board always claimed to expect that the market would be slow in the winter months as buyers and sellers came to grips with new mortgage rules, with a pickup later in the year as fundamentals reasserted themselves.  If those fundamentals now include slower economic growth and worsening employment prospects, that rebound may not show up.

Where does all of this leave the Bank?  The press release states that the outlook will still "warrant higher interest rates over time", but makes it clear that everything depends on the data.  Until recently, most analysts had expected three further rate hikes this year, more or less in line with the expected pace of Fed tightening.  At least one credible analyst (at BlackRock) sees no more than one more move this year, and conceivably no change at all.  One thing seems certain: the prospect of a trade war with Canada's biggest customer, coupled with the increasing likelihood that the Bank of Canada will lag the Fed in terms of tightening, means that the recent underperformance of the Canadian dollar will continue for some time to come.