Well, that didn't take long. Barely two weeks after the Bank of Canada ended five years of ultra-low interest rates by venturing a 25 basis point increase in its target rate, anonymous officials in Ottawa are apparently fretting via Bloomberg that the Bank's actions could trigger a slowdown in the economy.
Can this possibly be a reasonable fear? After all, the Bank's new target rate is only 0.75 per cent, and even if it follows through with another rate hike this year, as seems likely, that would still leave the rate negative in real terms -- and way below levels that were considered normal and manageable before the financial crisis hit. Most business economists interviewed by the media have dismissed the concerns of the unnamed bureaucrats, preferring to believe that the economy is in good shape to withstand not just another rate hike this fall, but also a couple more small upward moves during 2018.
I'm with the business economists on this one, but the truth is, nobody really knows, because we've never been here before. Ultra low interest rates and large-scale printing of money have never been tried before by any responsible central bank. Nobody envisaged that the QE-plus-free-money era would last the better part of a decade, engendering a belief on the part of many people that borrowing was essentially free and riskless. The elevated level of household debt in Canada is apparently a key factor underlying the concerns in Ottawa.
Thoughtful commentators warned years ago that stopping monetary stimulus would be a lot harder than starting it. The caution being shown by the Federal Reserve in raising rates and tapering QE clearly shows that central bankers are aware that they are flying without a compass here. Despite his more hawkish rhetoric in advance of the recent rate hike, it's apparent that Bank of Canada Governor Stephen Poloz is also minded to proceed with extreme caution, ready to reverse course if the economy reacts badly to gradual policy tightening.
As it happens, economic data released today clearly show why the Bank saw the need to start raising rates this month. Canada's GDP rose 0.6 per cent in May, far ahead of expectations. It now stands 4.6 percent above its year-earlier level, the strongest such gain since 2000. The Bank's expectation that the economy will reach effective full-capacity by the end of this year seems certain to be met. The strength in the exchange rate -- up 10 percent in the last two months -- will have to factor into the Bank's thinking at some point, but there is no reason to second-guess the recent change in its policy stance.
Friday 28 July 2017
Wednesday 26 July 2017
How soon is now?
Just about nobody had been expecting the Fed to raise the funds target again today. Thus, the only real point of interest in today's FOMC press release was the timing of the previously-announced plan to start unwinding QE (or balance sheet normalization, as the Fed prefers to call it). Would the Fed announce a timetable?
No, it would not. The press release simply stated that the FOMC "expects to begin implementing its balance sheet normalization program relatively soon". Exact timing, as with the further rate hikes that are surely coming, depends on the data flow.
It's hard to blame the Fed for keeping its cards close to its collective chest. No central bank has ever tried anything like QE before; the experiment has almost certainly run for much longer than the FOMC expected when it launched it; and there is no playbook for unwinding it. Ending QE will not be like pulling off a bandage, where the faster you do it, the less it hurts. Getting this wrong could be way more damaging than tightening rates a little too fast. All the same, a touch more clarity from the Fed today might have been helpful, if only to avoid the impression that it doesn't quite know how to proceed.
No, it would not. The press release simply stated that the FOMC "expects to begin implementing its balance sheet normalization program relatively soon". Exact timing, as with the further rate hikes that are surely coming, depends on the data flow.
It's hard to blame the Fed for keeping its cards close to its collective chest. No central bank has ever tried anything like QE before; the experiment has almost certainly run for much longer than the FOMC expected when it launched it; and there is no playbook for unwinding it. Ending QE will not be like pulling off a bandage, where the faster you do it, the less it hurts. Getting this wrong could be way more damaging than tightening rates a little too fast. All the same, a touch more clarity from the Fed today might have been helpful, if only to avoid the impression that it doesn't quite know how to proceed.
Sunday 23 July 2017
EU-phemism du jour
The dire warnings from the UK business sector about the consequences of a hard Brexit seem to be sinking in. UK Trade Secretary Liam Fox now says that it would be nice to have a transititional phase between the date certain that the UK leaves the EU (in March 2019) and the full severing of the UK's trading relationships with the Eurozone. In the usual UK style, Fox seems to imagine that the UK can not only impose such a transitional period on the EU, but also decree how long it should be.
After a month of shambolic "negotiations" on the UK side, the Europeans are starting to lose patience. Consider this quote from German auto boss Matthias Wittmann: "You need a transition period. We hope that on the British side that gets deeper and deeper into the intellectual capabilities of those who decide".
That's a charming way of putting it, possibly even nicer in German. What Herr Wittmann really means is "we hope the British can get this into their thick skulls". One can only say, if that's what Herr Wittmann hopes, he plainly hasn't spent much time with Liam Fox, or with his equally arrogant but incompetent colleagues, David Davis and Boris Johnson.
After a month of shambolic "negotiations" on the UK side, the Europeans are starting to lose patience. Consider this quote from German auto boss Matthias Wittmann: "You need a transition period. We hope that on the British side that gets deeper and deeper into the intellectual capabilities of those who decide".
That's a charming way of putting it, possibly even nicer in German. What Herr Wittmann really means is "we hope the British can get this into their thick skulls". One can only say, if that's what Herr Wittmann hopes, he plainly hasn't spent much time with Liam Fox, or with his equally arrogant but incompetent colleagues, David Davis and Boris Johnson.
Tuesday 18 July 2017
Donald Trump's NAFTA wishlist
A promise to rip up or at least renegotiate the North American Free Trade Agreement, "the worst trade deal in history", was a key part of Donald Trump's election platform. Six months after Trump's inauguration, his administration has now published a comprehensive list of what it hopes to get out of the renegotiation, which is supposed to begin around August 17. There are some important demands that will cause serious problems for Ottawa's negotiators, but the list also includes a number of items that would be widely welcomed by Canadian consumers.
Let's start with the problematic stuff:
Then there are the provisions that are likely to go down well with Canadian consumers:
Let's start with the problematic stuff:
- The US wants to eliminate entirely the dispute resolution mechanism in the current NAFTA agreement, known as Chapter 19. In a way this is a bit surprising: the US always seems to ignore judgments made against it under this chapter. Removing it is likely to be something of a red line for Canadian negotiators, particularly since the US recently imposed fresh tariffs against Canadian softwood lumber, and Chapter 19 would currently be the mechanism for attempting to resolve this issue, It is difficult to see how a free trade agreement can exist without some provision for handling disputes, but that will be the US position going in.
- Free trade agreements these days are as much about investment as trade in goods, and the US is seeking greater rights for US companies to make investments in Canadian or Mexican companies. Canada severely restricts or outright prohibits foreign ownership in a number of key sectors of the economy (banking; media; airlines) and this may well turn out to be an area of serious disagreement.
- The US appears to want asymmetrical rules on public contracts. While it wants US companies to have unfettered access to tenders in Canada and Mexico, it seeks to maintain its Buy America provisions (particularly close to President Trump's heart) and to exempt state and local government procurement altogether. Canada unashamedly favours domestic producers for large public contracts, often with disastrous results, as the fiasco of Toronto's streetcar deal with Bombardier shows. The problem at the negotiating table is likely to be the fact that many of these preferential deals originate at the provincial rather than national level; it will be difficult for federal negotiators to water them down.
Then there are the provisions that are likely to go down well with Canadian consumers:
- Although dairy products are not mentioned specifically in the US wishlist, Canada's extraordinary supply management system has been a bone of contention for many years. It represents one of the most egregious examples of "producer capture" to be found anywhere in the world. Production of milk, butter, cheese and eggs is subject to strict quotas and import restrictions, which keep the farmers profitable but mean that Canadian shoppers pay far more than their American neighbours for these staple food items. It's hard to imagine that many Canadians (aside from the influential farm lobby) would be sad to see the whole system blown up.
- Canadians face some of the world's most miserly limits on cross-border duty free purchases, with anything above C$ 20 subject to duty. The US wants that limit raised to C$ 800. This would bring joy to the legions of Canadians who line up at the border crossings here in Niagara each day on their way to American malls, but would deal a further severe blow to the ailing retail economy of the region.
Wednesday 12 July 2017
One small step for the Bank of Canada
The Bank of Canada raised its overnight rate target by 25 basis points to 0.75 percent today, in line with the very heavy hints dropped by Governor Stephen Poloz over the past few weeks. This was the first upward move in rates in seven years. The press release issued by the Bank was considerably longer and more detailed than usual. Surprisingly, however, neither the release nor Poloz's opening statement to the media made any mention of what many would consider to be the elephant in the room: the state of the housing market, especially in the Toronto area.
We'll come back to housing later, but let's focus first on the Bank's justifications for today's move. Poloz has extolled the strength of the Canadian economy in recent weeks as he has softened up the markets for a rate move. The Bank does not expect the 3.5 percent GDP growth rate seen in Q1 of this year to persist; it sees growth for 2017 as a whole at 2.8 percent, slipping to 2 percent in 2018 and 1.6 percent in 2019. However, it expects the output gap in the economy to disappear by the end of 2017, considerably sooner than previously forecast. Moreover, since the Bank sees the economy's potential growth rate as no more than about 1.5 percent, even the modest growth projected for the out-years of the forecast will trigger capacity constraints, and hence generate inflationary risks.
The imminent absorption of excess capacity in the economy is the driving factor behind today's action, but the Bank readily acknowledges that it is slightly incongruous to launch a tightening cycle while inflation is well below its 2 percent target. Both headline CPI and the trio of core measures used by the Bank have seen inflation stuck near 1.5 percent in the last several months. The Bank clearly believes this is driven by temporary factors, such as the electricity rebates being offered in Ontario by the increasingly desperate Wynne government. As these temporary factors wane and capacity use tightens, the Bank looks for CPI to move up to its target in 2018, with a slight overshoot of the target in 2019.
So, what about the housing market? All of the recent data confirm that the Toronto-area market, which was spiralling higher just three months ago, has hit a wall. Prices have fallen sharply, listings are up and the number of transactions is down. Ever since Governor Poloz started talking tough, personal finance experts in the media have been ramping up their warnings about how stretched some households' finances are, and urging those on floating rate mortgages to consider locking in a fixed rate. Gov. Poloz's rate hike hints have of course been reflected in the bond market, so fixed mortgage rates have risen even ahead of the Bank's actual move.
Given the possibility that higher rates could trigger problems for household finances, why has the Bank chosen to raise rates anyway? The obvious answer is that the Bank has to run its policy in the interests of the entire country; it cannot allow monetary policy to be dictated by the actions of panicky homebuyers in just one market, even one as dominant on the national stage as Toronto's undoubtedly is. Moreover, the Bank can clearly see that the long-awaited correction in the Toronto market is fully underway, rate hikes or no: the calming measures introduced by the Province of Ontario in April have had a much more rapid and profound effect than even the government itself can have expected.
Despite the lack of focus on it in the Bank's statements today, there can be no doubt that the reaction of the housing market will play a major part in the Bank's thinking as it ponders its next move. Gov. Poloz described the Bank's stance this way:
Data-dependent, then, as always. Markets appear to be looking for one more 25 bp hike this year, with a further 50 bp to follow in 2018. That looks about right, and would still leave rates well below historically normal levels.
We'll come back to housing later, but let's focus first on the Bank's justifications for today's move. Poloz has extolled the strength of the Canadian economy in recent weeks as he has softened up the markets for a rate move. The Bank does not expect the 3.5 percent GDP growth rate seen in Q1 of this year to persist; it sees growth for 2017 as a whole at 2.8 percent, slipping to 2 percent in 2018 and 1.6 percent in 2019. However, it expects the output gap in the economy to disappear by the end of 2017, considerably sooner than previously forecast. Moreover, since the Bank sees the economy's potential growth rate as no more than about 1.5 percent, even the modest growth projected for the out-years of the forecast will trigger capacity constraints, and hence generate inflationary risks.
The imminent absorption of excess capacity in the economy is the driving factor behind today's action, but the Bank readily acknowledges that it is slightly incongruous to launch a tightening cycle while inflation is well below its 2 percent target. Both headline CPI and the trio of core measures used by the Bank have seen inflation stuck near 1.5 percent in the last several months. The Bank clearly believes this is driven by temporary factors, such as the electricity rebates being offered in Ontario by the increasingly desperate Wynne government. As these temporary factors wane and capacity use tightens, the Bank looks for CPI to move up to its target in 2018, with a slight overshoot of the target in 2019.
So, what about the housing market? All of the recent data confirm that the Toronto-area market, which was spiralling higher just three months ago, has hit a wall. Prices have fallen sharply, listings are up and the number of transactions is down. Ever since Governor Poloz started talking tough, personal finance experts in the media have been ramping up their warnings about how stretched some households' finances are, and urging those on floating rate mortgages to consider locking in a fixed rate. Gov. Poloz's rate hike hints have of course been reflected in the bond market, so fixed mortgage rates have risen even ahead of the Bank's actual move.
Given the possibility that higher rates could trigger problems for household finances, why has the Bank chosen to raise rates anyway? The obvious answer is that the Bank has to run its policy in the interests of the entire country; it cannot allow monetary policy to be dictated by the actions of panicky homebuyers in just one market, even one as dominant on the national stage as Toronto's undoubtedly is. Moreover, the Bank can clearly see that the long-awaited correction in the Toronto market is fully underway, rate hikes or no: the calming measures introduced by the Province of Ontario in April have had a much more rapid and profound effect than even the government itself can have expected.
Despite the lack of focus on it in the Bank's statements today, there can be no doubt that the reaction of the housing market will play a major part in the Bank's thinking as it ponders its next move. Gov. Poloz described the Bank's stance this way:
Governing Council acknowledges that the economy may be more sensitive to higher interest rates than in the past, given the accumulation of household debt. We will need to gauge carefully the effects of higher interest rates on the economy.
Future adjustments to the target for the overnight rate will be guided by incoming data as they inform the Bank’s inflation outlook, keeping in mind continued uncertainty and financial system vulnerabilities.
Data-dependent, then, as always. Markets appear to be looking for one more 25 bp hike this year, with a further 50 bp to follow in 2018. That looks about right, and would still leave rates well below historically normal levels.
Sunday 9 July 2017
Forward to the past
I'm currently reading a new book in which I have a very modest proprietary interest: "The Lure of Greatness", by Anthony Barnett. It was crowd-funded, and you can find my name in a lengthy list of contributors in an appendix. I may say I find myself in some quite distinguished company!
The book originated in a series of articles Barnett, who is the founder of the excellent Open Democracy website, wrote in the first half of 2016, under the umbrella title "Blimey! It could be Brexit!" When, blimey, it actually was Brexit, Barnett set about crafting the articles, plus his further thoughts, into a book. While he was working on that, blimey (or maybe FFS) it was Trump, and Barnett went back to the drawing board to incorporate US developments into his book, which delayed its appearance until now.
Barnett's principal explanation for the shocking results of the UK referendum and the US election is surprisingly simple, and rests principally on the central campaign slogans of the two winning sides. In the UK, the Brexiteers' war-cry was "Take Back Control", while in the US Donald Trump famously pledged to "Make America Great Again".
Barnett suggests that the precise wording of these slogans was the key to their success. If the Brexit slogan has simply been "Take control", it would have been too vague to achieve anything. "Take back control" convinced a certain proportion of the electorate that Britain had given something up by joining the EU, and of course appealed in a subtle way to the ever-lingering sense of resentment of (and superiority to) foreigners that can still be felt in British society.
Likewise for Donald Trump. Simply saying "Make America Great" would have allowed Trump's opponents to respond "are you saying this isn't a great country'?" Adding the word "again" appealed at a visceral level to voters who felt that something had gone wrong, even if they couldn't quite understand what, and promised a return to a fuzzily-remembered but more agreeable past.
Both slogans, in short, worked because they combined a promise of change with a hefty dose of nostalgia: not back to the future, but forward to the past. Barnett believes that the ready acceptance of this message in both the UK and the US reflected a loss of trust between a broad swath of the population and its political leaders. He attributes this loss of trust in the group he denotes as "the CBCs" (Clinton, Bush, Blair, Cameron) to their shameless deceit over the Iraq war, maladroit response to the financial crisis and the ever-rising level of income inequality.
There's no doubt that by 2016, a lot of voters in both the UK and US were so disillusioned with the status quo that they wanted to blow things up, and would vote for anyone who promised to do that. The irony, of course, is that this led to the triumph of two campaigns that were much more mendacious at their root than anything "the CBCs" ever came up with. The Brexit referendum and the election of Donald Trump proved to a large proportion of the electorate, many of whom had never taken much interest in politics before, that their voices could be heard. Whether those voters will be happy with what their votes delivered remains to be seen.
The book originated in a series of articles Barnett, who is the founder of the excellent Open Democracy website, wrote in the first half of 2016, under the umbrella title "Blimey! It could be Brexit!" When, blimey, it actually was Brexit, Barnett set about crafting the articles, plus his further thoughts, into a book. While he was working on that, blimey (or maybe FFS) it was Trump, and Barnett went back to the drawing board to incorporate US developments into his book, which delayed its appearance until now.
Barnett's principal explanation for the shocking results of the UK referendum and the US election is surprisingly simple, and rests principally on the central campaign slogans of the two winning sides. In the UK, the Brexiteers' war-cry was "Take Back Control", while in the US Donald Trump famously pledged to "Make America Great Again".
Barnett suggests that the precise wording of these slogans was the key to their success. If the Brexit slogan has simply been "Take control", it would have been too vague to achieve anything. "Take back control" convinced a certain proportion of the electorate that Britain had given something up by joining the EU, and of course appealed in a subtle way to the ever-lingering sense of resentment of (and superiority to) foreigners that can still be felt in British society.
Likewise for Donald Trump. Simply saying "Make America Great" would have allowed Trump's opponents to respond "are you saying this isn't a great country'?" Adding the word "again" appealed at a visceral level to voters who felt that something had gone wrong, even if they couldn't quite understand what, and promised a return to a fuzzily-remembered but more agreeable past.
Both slogans, in short, worked because they combined a promise of change with a hefty dose of nostalgia: not back to the future, but forward to the past. Barnett believes that the ready acceptance of this message in both the UK and the US reflected a loss of trust between a broad swath of the population and its political leaders. He attributes this loss of trust in the group he denotes as "the CBCs" (Clinton, Bush, Blair, Cameron) to their shameless deceit over the Iraq war, maladroit response to the financial crisis and the ever-rising level of income inequality.
There's no doubt that by 2016, a lot of voters in both the UK and US were so disillusioned with the status quo that they wanted to blow things up, and would vote for anyone who promised to do that. The irony, of course, is that this led to the triumph of two campaigns that were much more mendacious at their root than anything "the CBCs" ever came up with. The Brexit referendum and the election of Donald Trump proved to a large proportion of the electorate, many of whom had never taken much interest in politics before, that their voices could be heard. Whether those voters will be happy with what their votes delivered remains to be seen.
Friday 7 July 2017
Bank of Canada: good to go?
There seems to be very little reason for the Bank of Canada to hold off on raising rates when its Governing Council meets on July 12. Start with the fact that Governor Stephen Poloz has taken his newly hawkish message on a virtual world tour: after first broaching the subject of higher rates in an interview in Winnipeg, he delivered the same message at an ECB-sponsored conference in Portugal, and this week followed that up with yet more of the same in an interview with a major German newspaper.
It's a mistake for a central banker to send those kinds of signals and then not follow up, particularly as the flow of economic data in the past two weeks has been generally supportive of the case for higher rates. In particular, the latest set of employment data, released earlier today, shows continuing strength in the labour market. The economy added 45,000 jobs in June, which caused the unemployment rate to tick down to 6.5 percent.
Although most of the jobs were part-time and most of the gains were seen in just two Provinces (Quebec and BC), the June report means that the economy has added 351,000 jobs in the last year, the fastest pace for any twelve-month period since 2009. Almost 250,000 of those jobs have been full-time, with the result that the number of hours worked in the economy has grown by 1.4 percent in the past year.
The strong gains in employment through the entire second quarter -- up 0.6 percent over Q1 -- are a clear signal that the strong GDP growth seen in the final quarter of 2016 and the first three months of this year has persisted. April GDP data, released a week ago, appeared to confirm this, with GDP by industry posting a 0.2 percent month-on-month rise. Aside from a pullback in manufacturing, the gains were broad-based -- and in a uniquely Canadian touch, StatsCan noted that strong growth in the arts, recreation and entertainment sector was driven by the fact that five Canadian teams reached the end-of-season hockey playoffs! (As this is a serious blog post, we will pass over the fact that the final saw Pittsburgh triumph over Nashville).
Given the strong macroeconomic data, what could hold the Bank back next week? The only real candidate is the housing market, which seems to be on the verge of a full-scale correction, especially in the Greater Toronto region. The average selling price for a home in the region fell by 8 percent in June; any comparable decline in July would see the year-on-year change, which topped 30 percent in the first part of this year, slip into negative territory, which would be quite remarkable. Rising listings and a falling number of completed deals are further evidence that the market has changed drastically since the Provincial government introduced its package of calming measures back in April.
You can certainly make a case that housing has been a major driver of the economy in recent years -- but not in any sense that a prudent central bank would be likely to favour. Low interest rates have largely failed to encourage any increase in new home construction, even though this is much needed. Instead, what they have driven is a rapid increase in household debt, initially in the form of mortgages, but more recently in the pernicious shape of home equity lines of credit (HELOCs), which have been showing explosive growth.
It may well be the case that a rate hike by the Bank next week will curb consumer behaviour, though it's worth noting that the Bank will, if anything, be lagging the market here: banks are already raising their mortgage rates, so the highly-indebted consumer is about to get squeezed whether the Bank does anything or not. Monetary stimulus will have to be removed at some stage, and with the economy in its best shape in almost a decade, this is looking like the right time to start. A 25 bp rate hike seems certain to come on July 12, with the Bank possibly signalling one further hike before year end, assuming of course that the data flow remains favourable.
It's a mistake for a central banker to send those kinds of signals and then not follow up, particularly as the flow of economic data in the past two weeks has been generally supportive of the case for higher rates. In particular, the latest set of employment data, released earlier today, shows continuing strength in the labour market. The economy added 45,000 jobs in June, which caused the unemployment rate to tick down to 6.5 percent.
Although most of the jobs were part-time and most of the gains were seen in just two Provinces (Quebec and BC), the June report means that the economy has added 351,000 jobs in the last year, the fastest pace for any twelve-month period since 2009. Almost 250,000 of those jobs have been full-time, with the result that the number of hours worked in the economy has grown by 1.4 percent in the past year.
The strong gains in employment through the entire second quarter -- up 0.6 percent over Q1 -- are a clear signal that the strong GDP growth seen in the final quarter of 2016 and the first three months of this year has persisted. April GDP data, released a week ago, appeared to confirm this, with GDP by industry posting a 0.2 percent month-on-month rise. Aside from a pullback in manufacturing, the gains were broad-based -- and in a uniquely Canadian touch, StatsCan noted that strong growth in the arts, recreation and entertainment sector was driven by the fact that five Canadian teams reached the end-of-season hockey playoffs! (As this is a serious blog post, we will pass over the fact that the final saw Pittsburgh triumph over Nashville).
Given the strong macroeconomic data, what could hold the Bank back next week? The only real candidate is the housing market, which seems to be on the verge of a full-scale correction, especially in the Greater Toronto region. The average selling price for a home in the region fell by 8 percent in June; any comparable decline in July would see the year-on-year change, which topped 30 percent in the first part of this year, slip into negative territory, which would be quite remarkable. Rising listings and a falling number of completed deals are further evidence that the market has changed drastically since the Provincial government introduced its package of calming measures back in April.
You can certainly make a case that housing has been a major driver of the economy in recent years -- but not in any sense that a prudent central bank would be likely to favour. Low interest rates have largely failed to encourage any increase in new home construction, even though this is much needed. Instead, what they have driven is a rapid increase in household debt, initially in the form of mortgages, but more recently in the pernicious shape of home equity lines of credit (HELOCs), which have been showing explosive growth.
It may well be the case that a rate hike by the Bank next week will curb consumer behaviour, though it's worth noting that the Bank will, if anything, be lagging the market here: banks are already raising their mortgage rates, so the highly-indebted consumer is about to get squeezed whether the Bank does anything or not. Monetary stimulus will have to be removed at some stage, and with the economy in its best shape in almost a decade, this is looking like the right time to start. A 25 bp rate hike seems certain to come on July 12, with the Bank possibly signalling one further hike before year end, assuming of course that the data flow remains favourable.
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