Friday, 23 June 2017

Canada inflation lower; house prices too

Remarks last week by Bank of Canada Governor Stephen Poloz and his senior deputy, Carolyn Wilkins (see earlier post, Loonie turns on a dime), led a number of analysts to conclude that the start of a policy tightening cycle in Canada might be closer than anyone had previously thought.  Both officials noted the broadening strength in the economy, with Poloz specifically stating that the Bank's rate cuts had "done their job".

Well, maybe so, but May CPI data released by Statistics Canada today suggest the Bank still has plenty of room for manoeuvre.  Headline CPI rose just 1.3 percent year-on-year in the month, down from 1.6 percent in April. Food and energy prices, always subject to volatility, heavily influenced the headline number, but the various core measures introduced by StatsCan last year all tell a similar story: consumer inflation is well below the Bank's 2 percent target, and showing no real sign of moving up any time soon.  It would be surprising and indeed unprecedented for the Bank to initiate a tightening cycle under these circumstances; the likely timing for the first rate move is still the first half of 2018.

Meantime, there are growing signs that the real estate market in the Toronto area, a major concern for the Bank (not to mention the IMF and the OECD) has hit a brick wall. Data for the first half of June show a further fall in selling prices, a rise in the number of homes listed and a fall in actual transactions.   Realtors are trying to put a brave face on the data, describing June as "normally a quiet month", but there seems to be more than that happening.

Reports are starting to surface of buyers whose offers were accepted before the correction began (in late April) discovering that their mortgage providers are now assessing the properties at a lower than expected value, and reducing their loans accordingly.  This is starting to raise the possibility of supposedly agreed transactions collapsing in a flurry of foregone deposits and acrimony.  It's no surprise that buyers are increasingly taking a wait-and-see attitude, in the hope that the market will come to them.  An outright collapse in prices is still unlikely because of Toronto's underlying demographics.  However, those realtors who confidently claimed that the slowdown would be brief look increasingly likely to be proved wrong.

All good news for the Bank of Canada and the underlying economy then, right?  Well, yes, but then there's this. It seems that consumers are still enthusiastically building up their debts: the average household now owes more than $22,000 in addition to its mortgage debt.  Delinquency rates and other signs of distress remain comfortingly low, but that's hardly surprising with interest rates at today's levels. It's perhaps just as well that the Bank of Canada has room to postpone any tightening steps for a few months more, because it's not at all clear how households, and by extension the overall economy, will react once rates finally start to edge higher.

Tuesday, 20 June 2017

Brexit = stagflation?

Just about everyone except the most blinkered observers (hi there, Jacob Rees-Mogg) recognizes the damage that Brexit is likely to cause to the UK economy and society.  Loss of jobs if free trade is not maintained?  Check.  Evisceration of London's leading role in European financial markets?  Check.  Possible unwinding of the Good Friday agreement that has produced something like peace in Northern Ireland?  Check.  Strains on social services as key EU workers return home, to be replaced by embittered, elderly expat Brits displaced from the Costa del Sol?  Check.

Now we have the Governor of the Bank of England, Mark Carney, weighing in on the risks to the overall economy. In a remarkable speech at Mansion House,  Carmey has warned that the risks that Brexit poses to the health of the UK economy are so severe that this is "not the time" to start adjusting monetary policy.  He baldly states that "the Bank cannot prevent the weaker income growth likely to accompany the transition to new trading arrangements with the EU", but that it can influence how "the hit to incomes is distributed between job losses and price rises".

Quite simply, this means that the Bank is abandoning its 2 percent CPI target for as long as the Brexit uncertainty exists.  As recently as October 2015, UK year-on-year inflation was virtually zero.  It edged up in the months after that, but by the time of the Brexit vote last June it was still below 1 percent.  Since that vote, inflation has been rising steadily, and in May reached 2.7 percent, the highest level seen since the first quarter of 2012.  Under normal circumstances the Bank would have begun raising rates some months ago, but Carney is signalling that he can't and won't be doing any such thing, given the very delicate state of the economy.

It's a dismaying prospect -- little or no GDP growth accompanied by rising prices, and the Bank almost powerless to do anything about either.  The term "stagflation" was regularly used to describe the UK back in the 1970s.  Although nobody now expects inflation to rocket up to 20 percent as it did back then, the word itself may come back into common currency.

A final thought:  Governor Carney needs to watch his back.  The more rabid Brexiteers, led by the aforementioned Rees-Mogg, were after his scalp when he dared to speak out during the referendum campaign.  Today's comments, with the die already cast, may be even more provocative.  Come to think of it, Chancellor of the Exchequer Philip Hammond, who seems to share many of Carney's concerns, might also want to polish up his CV.

Wednesday, 14 June 2017

The Fed's new normal

In line with expectations, the Fed increased its target funds range to 1-1.25 percent at the end of the two-day FOMC meeting.  The accompanying statement stresses that monetary policy "remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation".

The statement leaves little room for doubt that the Fed expects to raise rates further, though it stresses that the timing and extent of any future increases will depend on the data flow, particularly as regards employment and inflation. However, "the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run".

For now, the Fed is continuing to reinvest the principal amounts of the bonds it acquired during its QE program as they mature.  However, it intends to start a program of normalization of its balance sheet before the end of this year, assuming the economy evolves as expected. To this end, it released today a brief but informative document on how this process will work.  (Answer: slowly.) Downsizing the balance sheet is likely to prove a lot trickier than returning interest rates to more normal levels, a fact that the Fed clearly recognizes: "The Committee expects to learn more about the underlying demand for reserves during the process of balance sheet normalization".

The Fed is at pains to stress that is not about to take away the markets' punchbowl entirely.  It expects that its balance sheet, at the end of the normalization process, will be larger than it was before the financial crisis and QE.  It also reassures the market that the Fed will be willing to re-commence securities purchases at any time in the future, if it deems that such a step is necessary to support the economy.  Things may be very slowly heading back towards "normal", but evidently normal isn't what it used to be.

Tuesday, 13 June 2017

Loonie turns on a dime

The Canadian dollar has rallied by well over a cent against the US dollar in the first two trading sessions of this week, as the Bank of Canada abruptly adjusts its rhetoric on the economy and the interest rate outlook.  Monday saw Senior Deputy Governor Carolyn Wilkins, speaking in Winnipeg, extolling the strength of the Canadian economy and musing aloud about whether the current "significant" monetary stimulus remains appropriate.

As regards the timing of any possible steps to remove some of that stimulus, she used an analogy: "If you saw a stop light ahead, you would begin letting up on the gas to slow down smoothly. You don't want to have to slam on the brakes at the last second. Monetary policy must also anticipate the road ahead".  The Bank's stop light is, of course, its inflation target, and as it has repeatedly reminded us in recent months, headline and core inflation measures remain well below the Bank's 2 percent goal.  Moreover, the very low wage increases that continue to be reported even as employment grows suggest that the Bank still has a bit of road to play with before it has to ease off the gas.

Meanwhile, back in Winnipeg....this morning, Bank Governor Stephen Poloz gave an interview to one of that city's radio stations in which he, too, lauded the recent performance of the Canadian economy.  He suggested that this meant that the interest rate cuts implemented by the Bank two years ago had done their job, but cautioned that it wasn't yet time to "throw a party".

The Bank has still left itself plenty of wriggle room here, but Wilkins' and Poloz's statements are by far the clearest indication to date that the Bank's ultra low rate policy must be brought to an end at some stage. This has set analysts at the banks and elsewhere into a frenzy of forecast revision, with many now looking for the first rate hike to come before the end of this year, rather than in the first half of 2018 as most had previously expected.

The Bank of Canada will no doubt spell out its intentions more clearly at in next rate-setting meeting on July 12.  Nobody is expecting a rate hike to come then, but the tone of the rhetoric in the statement, and in the accompanying documents detailing the Bank's forecast, will bear close scrutiny.

Friday, 9 June 2017

Canada jobs data: wow!

A couple of times each year, Canada releases its employment data a week after the US non-farm payrolls report.  This is done for technical reasons.  This was one such month, but given the data that StatsCan released this morning, you'd be tempted to think they were doing it to secure bragging rights.

Recall that the US data for May showed that the economy added 138,000 jobs in the month, a figure that was generally seen as a disappointment.  Well, StatsCan's data* today showed that the Canadian economy added 55,000 jobs in the month, against an analyst consensus of about 15,000.  On the usual 10:1 comparison between the two economies, that's the equivalent of a US non-farms gain of more than 500,000 jobs.

The details of the report were equally impressive.  Full-time jobs rose by 77,000 in the month, offset by a fall in part-time positions.  Moreover, almost all the new jobs were in the private rather than the public sector, and there was little sign of the volatility in "self employment" that occasionally renders these reports suspect.  Moreover, there was considerable strength in the manufacturing sector, which added 25,000 jobs in the month, though given that this sector may be at particular risk once the NAFTA renegotiations begin, these gains may not be sustained.

The unemployment actually ticked up to 6.6 percent in the month.  However, since this reflected "encouraged" workers returning to the jobs market, it does not materially detract from the strong overall tenor of this report.

Sustained strong employment growth over the past several months means that the economy has added 317,000 jobs in the past year, the strongest year-on-year growth since early 2013.  In more normal times, such a development would have the central bank starting to think about tightening policy.  There's no doubt that today's report will nudge the Bank of Canada's thinking in that direction, but an early rate move remains unlikely because wage gains, at just 1 percent year-on-year, remain so tame.  Some analysts are suggesting that if the job market continues to tighten in this way, wage gains will start to take off, and the Bank will be forced from the sidelines.  That's a reasonable hypothesis, but with headline inflation still just as tepid as wage growth,  the Bank is highly unlikely to start the tightening process until 2018.

*Apologies for not providing a link to the StatsCan release itself.  Their website is down (again).

Thursday, 8 June 2017

Stability now?

This morning the Bank of Canada released its Financial System Review, a semi-annual report in which Bank sets out and analyzes what it sees as the key risks to the stability of the domestic financial system.  By way of an appetizer, yesterday had seen releases on related topics from two respected sources.  First, the OECD warned of the growing risks posed by the soaring housing market, and urged governments to do more to bring prices back to more sustainable levels.  Then, the government's own Financial Consumer Agency of Canada warned of the soaring use of home equity lines of credit by a rising number of Canadian households,  Use of these so-called HELOCs has contributed in no small way to the rise in household indebtedness to all-time record levels.

The Bank's own Review begins by noting that the two key vulnerabilities of the domestic financial system -- household debt and imbalances in the housing market itself -- have both worsened in the last six months. The quality of government-insured mortgage debt is improving, in the wake of tighter rules imposed last year.  However, uninsured mortgages are growing more rapidly, and there are indications that the credit quality of some of these mortgages is deteriorating.

The Review assesses two ways in which high house prices and high household debt could turn problematic:

  • an externally-driven recession, in which the housing market would be but one of the ways in which the economy takes a hit.  Rising unemployment would put household finances under pressure, potentially affecting the stability of the financial system.  The Bank warns that the impact of such an external shock could be severe, but it judges that the likelihood of such an event is low, given improving global growth prospects.  This optimistic view of the macro outlook is largely in line with the aforementioned OECD report, which sees global GDP growth of 3.7 percent this year and slightly higher in 2018.


  • a sudden correction in house prices, particularly in the Toronto and Vancouver areas.  The Bank sees this as a more probable event than a recession, but believes that the impact on the overall economy and on the financial system would be significantly smaller.  Given the rapid response of Toronto-area house prices to the measures taken by the Ontario government in April to cool the market, the risk of a sharp and uncontrolled correction may in fact already have diminished to some extent. 

There are two key takeaways here.  The first, explicitly stated by the Bank, is that "the financial system remains resilient", which is obviously good news.  The second, not explicitly stated, is this: if the Bank sees a recession as a more severe risk, albeit less probable,  than a housing market correction, it will obviously continue to set monetary policy mainly with an eye to keeping the economy growing.  A number of commentators have begun to suggest that rate hikes are starting to loom larger in the Bank's thinking; the Financial System Review suggests this is not yet the case.  

Monday, 5 June 2017

Is the house party over?

Some startling statistics today on the performance of the Toronto area housing market in May.  Data from the Toronto Real Estate Board (TREB) show a sharp decline in both sales activity and the average selling cost of homes during the month.

As often happens, the Toronto Star's headline-writing sub has failed to grasp the gist of the article.  The headline states that "The average home price last month was $863,910 -- $111,810 more than last May".  That's true, but the real story is that the average price fell by more than $55,000 in the month from the all-time peak of $920,000 reached in April.  The year-on-year percentage increase, which has been in excess of 30 percent for most of this year, fell to 15 percent in May.

There's more.  Listings of homes available for sale were up almost 10 percent from April to May, to stand almost 50 percent higher than in May 2016. However, the number of transactions completed fell in the month, with sales of detached homes down 26 percent from a year ago.

Given all of this data, can we conclude that the package of sixteen measures announced by the Province to cool the market back in April is having the desired effect?  It certainly looks that way, at least in the short term.  The rise in listings suggests that sellers may now fear they have missed the boat and are getting their properties to market before prices fall even further.  The fall in the number of completed transactions, meanwhile, suggests that buyers are now more inclined to take a wait-and-see approach, rather than chasing blindly after every available property, as had been happening previously.

The fall in sales of detached homes is particularly instructive.  Given the perceived lack of supply, this had been the category that had shown the most dizzying increase in the past year.  The fact that it has gone into reverse so quickly may be the clearest indication that a level of sanity has returned to the market.  Will it last? It is apparent that the Province's measures have introduced a degree of caution and uncertainty into the market that was not there before.  That's a good thing in itself.  However, lessons from the imposition of similar measures in Vancouver a year ago suggest that the pause may prove only temporary, lasting only as long as it takes for the market to strike a new equilibrium.  For sure, as long as mortgages are cheaper than dirt, it will be hard to rein the market in entirely.  Still, the May numbers are encouraging -- unless, of course, you're one of those people who waited just a bit too long to list your home for sale.