Bank of Canada will stand pat in October

When the Bank of Canada raised its rate target by 25 basis points in September, the second such increase in less than three months, it faced some criticism on the basis that it had failed to signal its intentions to the market.  This was somewhat unfair, since in fact the market was pricing in a better-than-evens chance of a rate hike by the time decision day rolled around.  It was the consensus among analysts that called it wrong. Still, given Governor Poloz's proclivity for crossing up the market in the early months of his tenure -- something he has since corrected -- there were some grounds for concern over the Bank's communications strategy.

A major speech by Gov. Poloz this week in St John's seems to have convinced both markets and analysts that there will be no further rate move when the Bank's Governing Council meets on October 25.  The speech is worth reading for the insights it provides into the concept of "data dependence" in decision making.  Data are always about the past, and the Bank needs to form policy based on where the economy is going rather than where it has just been.  Thus the Bank augments its use of formal economic models with soft data and judgment in order to reach a view on where monetary policy needs to be set.

This approach allowed the Bank to start toughening up its rhetoric earlier this year, once it perceived that the economy was on track to reach full capacity by year end.  When the GDP growth rate exceeded expectations in the first half of the year, the stage was set for the rate increases that were duly delivered in July and September.  However, as Gov. Poloz emphasized in St John's, the Bank is aware that both positive and negative shocks may lie in the future, so it is not predetermined that the path of interest rates will move steadily higher. 

Some of the recent economic data point to the need for caution on the Bank's part.  Most notably, real GDP stalled in July after eight months of steady gains.  Weakness in goods production, including manufacturing, may suggest that the recent strength in the exchange rate is beginning to have an impact, a possibility alluded to by Gov. Poloz in his speech. The Bank will also want to judge whether the recent sharp slowdown in the housing market, notably in the Toronto region, may be starting to affect consumer confidence and hence household spending.

Longer-term factors may also be turning more negative.  Gov. Poloz delicately referred to rising trade protectionism "in some parts of the world", but just a day before he spoke there was a sharp reminder of just which part of the world Canada needs to be concerned about.  The startling US judgment against Bombardier Inc.'s aircraft division, proposing a 220 percent tariff on the company's jets, seems to have been heavily influenced by the Trump administration: the complainant, Boeing, had sought a tariff of "only" 80 percent.

The Bombardier decision comes amid increasing signs that the NAFTA renegotiations are not going smoothly, with the US making demands that are either unreasonable (e.g. on Buy America rules) or vague (e.g. on domestic content rules for vehicles). It is quite likely that the talks will not conclude by year end, and very possible that a deal will not be reached at all, prompting Trump to pull the US out of the existing agreement.

All in all, plenty of reason for the Bank to take a cautious approach going forward, beginning with no move on October 25.   

Uneasy

One of the new offerings that showed up on our Netflix menu this month was Easy Rider, described as a "counter-culture classic". My wife had never seen it, so we thought we'd give it a go.  We were a little surprised by how poorly it was rated by the Netflix audience -- but then we watched it and all became clear.

The movie is a real dog's breakfast.  The first half is basically a hippy travelogue. The dialogue is mostly unscripted, which is not a good thing.  Director Dennis Hopper uses lots of long tracking shots of the magnificent scenery of the US west, with the protagonists (Hopper and Peter Fonda) engaging in mumbled conversations with each other and the various folks they meet.

Things start to take a darker turn when Jack Nicholson enters the "story" as a low-rent lawyer.  Jack is a far better actor than either Hopper or Fonda, and he leers his way through the middle of the movie before meeting a violent end.

Hopper and Fonda make their way to Mardi Gras in New Orleans (that's the "easy" part in the title). Neither the city nor its famous bacchanal looks the least bit appealing here.  Hookers are hired, drugs are consumed and the pretty tableaux of the first half of the movie are replaced by a blurry series of cross-cuts that are evidently intended to simulate the effect of LSD.

And then suddenly we're back on the bikes again, and the movie reaches a sudden and violent conclusion.  It's all wrapped up in just over 90 minutes but it seems much longer.

I don't remember Easy Rider as being this bad when I first saw it and I certainly don't recall the sixties being as tawdry as this.   Still,  at least the music stands the test of time -- well, apart from "If you want to be a bird".

Enough of the self-abuse, Justin

This past July marked 150 years since the establishment of the confederation of Canada, which started out with just four Provinces.  An occasion for celebration, you might think, and for much of the country it was just that.  In Ottawa, however, there was a distinct odour of self-loathing. Commemoration of the country's many real achievements was almost entirely drowned out by hand-wringing over the way the country has mistreated its indigenous peoples.  Anti-Trudeau segments of the media were vocal in castigating the government for setting such a downbeat tone on a supposedly happy occasion.

It hardly need be said that the treatment of indigenous peoples by Canada (and by our larger neighbour to the south) has been shockingly bad.  Best estimates suggest that there were about 25 million people living in North America when the white man "discovered" the place.  A very high percentage were killed by diseases to which they had no natural immunity (notably smallpox) and the rest were either penned into smaller and smaller tracts of their traditional territories or subjected to forced assimilation. It's not without justification that Canada's indigenous peoples like to render the first line of the national anthem as "O Canada, our home on natives' land".

Given this sad history, you can certainly make a case for the Government to acknowledge past transgressions at the Sesquicentennial celebrations, and to pledge to do better in the future.  After all, that was directed mainly at a domestic audience.  But how, then, do we explain Justin Trudeau's frankly bizarre speech to the United Nations General Assembly in New York this week?

At a time when madmen in Washington and Pyongyang are uttering blood curdling threats of nuclear annihilation; a time when a Nobel Peace Prize winner is presiding over ethnic cleansing in Myanmar; and a time when the ongoing stream of refugees on Europe's southern shores is starting to be matched by a similar influx at Canada's southern border, Trudeau chose to air Canada's dirty linen to the world. Much of his speech focused on the sins many generations of white Canadians have visited on their indigenous neighbours, leaving many still living in inadequate housing, with no access to clean water and facing poverty, unemployment and a variety of addiction issues. He also described to the Assembly members, who must have been mildly bemused by this detail, the steps his Government is taking to try to fix the problem, including splitting responsibility for indigenous affairs between two ministries instead of one.  

Worthy as all of this is, it's surely a matter for domestic consumption rather than something to be paraded before the most distinguished international assembly in the world. What makes this even harder to explain is that Canada has been busily lobbying for a seat on the UN Security Council.  Trudeau described Canada as "a work in progress"; it may well be that the Security Council will tell him to apply again when he's finished his homework.

Just a small deficit

Canada's Department of Finance has released its Annual Financial Report, and at least on the surface, it's mostly good news.  The Federal deficit for the year to March 2017 was C$ 17.8 billion, far higher than the $ 1 billion shortfall in the preceding fiscal year but markedly lower than the $23.0 billion projected in the budget back in February.

The way in which the smaller-than-expected deficit was reached is a little confusing. Revenues actually fell by $ 2 billion (less than 1 percent) from the preceding year, but the shortfall was smaller than had been expected at budget time. Program spending increased by more than 5 percent,  well above the rate of inflation, but this was less than had been budgeted.  Lastly, public debt service charges were slightly lower than budgeted because interest rates remained lower than the Department of Finance had projected.

It is unlikely that the smaller-than-expected deficit for the Government's first full fiscal year will be repeated in the near term. The Trudeau government has intentionally set out on a fiscal path that aims to stimulate the economy through a multi-year pattern of deficit spending. While the strong economy may keep revenues buoyant for much of the current fiscal year, program spending is unlikely to remain below target.  The Financial Report notes that much of the shortfall in spending in the year to March reflected slow disbursement of infrastructure transfers to Provinces and municipalities. Infrastructure investment was a major plank in the Liberal election platform, and it is very likely that the Government will do everything it can to get the money out the door more effectively from now on.

Is the prospect of continuing deficits anything to worry about?  The Department of Finance doesn't want you to think so. Page 10 of the linked report has a graph showing deficits as a percentage of GDP over a three-decade stretch.  The 2016-17 shortfall equates to just 0.9 percent of GDP.  This is certainly way smaller than the 4-5 percent shortfalls routinely seen at the start of the 1990s, a period of insanity that we can hope no-one in Ottawa wishes to repeat.  

Perhaps more pertinently, the Financial Report notes that the net debt of the entire public sector stands at just 27 percent of GDP.  This is by far the lowest in the G-7 -- indeed the average for that group is apparently 83 percent, though this is heavily influenced by the outsized debt of Japan and, to a lesser extent, Italy.  In truth, Canada's fiscal position is not a major cause for concern, but it would be a huge surprise if we don't start to hear the opposition decrying Trudeau's "financial irresponsibility" as we start to head towards, oh joy, the 2019* general election.

* Originally I stated wrongly that the Federal vote would be in 2018. We already have the tantalizing prospect of Provincial and municipal elections next year, so the trifecta of adding in the Feds as well would have been altogether too much!

Yawn! Household debt hits another new record

Statistics Canada reported this morning that the household debt to income ratio in Canada jumped more than one percentage point in the second quarter of the year, reaching a new all-time high of 167.8 percent.  At the same time, household net worth (which primarily means the equity value in family homes) fell slightly. Separately, survey data suggest that reliance on home equity lines of credit continues to increase and that seniors are. remarkably enough, now going into debt at a faster rate than younger Canadians. Is there any way that this debt spree ends well?

Logically, we should be at a pivot point now.  Consider these factors:

• House prices have been falling in the key Toronto market since April, when the Ontario Provincial Government announced a package of measures to calm the market.  Falling house prices should mean that those Canadians still looking to enter the housing market will need to take on less debt in order to do so.

• The collapse of housing prices should have alerted people to the fact that a stable level of household net worth (i.e. the equity in the family home) is scant consolation when debt is too high.  Over the past four months or so, millions of people have seen the value of their home fall sharply, and the marketability of that home dwindle, while their debt burden has remained unchanged. Now that StatsCan is reporting a small decline in household net worth for Q2,  this truth should be doubly apparent.

• The modest rate increases delivered by the Bank of Canada since June, and the evident risk that more will soon follow, have triggered a tsunami of advice from financial advisors, urging Canadians to ensure that their debt burden remains manageable.  

None of these three factors has been in place for very long, and they can have had little if any impact on the Q2 data released this morning.  The current quarter is a different matter: if, in the face of these cautionary signals, it emerges that households have continued to amass further debt, there will be only two possible conclusions,  neither of them palatable.  Either Canadians are too reckless to rein in their debts when they clearly should, or they are simply unable to do so.  If debt continues to increase, the Bank of Canada will have to think long and hard about how far and how fast it can tighten monetary policy. 

And I bet she voted for Brexit

True story.  This past Sunday morning I was waiting near the main gate of Christ's College in Cambridge, waiting for my sister to pick me up.  There was a lot going on. Graduates I had enjoyed a reunion bash with the previous evening were dropping off their keys at the Porters' Lodge and taking their leave.  People who had been attending an engineering conference in college were also bringing their bags for storage and preparing to leave town.  And there was a charity walk under way, with hundreds of people parading in an almost unbroken stream through the college for local good causes. There were army cadets waving big, green styrofoam fingers to show them the way.

Two Polish ladies who had been at the engineering conference came to the Porters' Lodge, paid their bills, handed in their keys and asked for their luggage to be stored.  Then they came out to the courtyard (which dates back almost half a millennium) for a last look round.  There's quite a small sign asking visitors not to walk on the exquisitely manicured lawn;  only Fellows of the college are permitted to set foot on the hallowed turf.  Maybe they didn't see the sign because of the stream of charity walkers, or maybe they didn't care, but one of them walked a few paces onto the grass to get a better angle for a selfie.

She was immediately spotted by the porter who was returning from putting her bags in storage. He called out in a loud voice, "Off the grass, please".  She obeyed at once, but not before the charity marchers had taken notice.  As they passed me, one middle-aged female walker said quite loudly to her companion. "There's always one, isn't there?"

Stephen can't wait

By the time the Bank of Canada's rate decision was announced by Gov. Stephen Poloz this morning, financial markets were pricing in a better-than even chance of a rate hike.  In contrast, a majority of business economists did not expect the Bank to move until October, when it is due to release its updated economic outlook.  One-nil to the market, then: the Bank raised its overnight rate target by 25 basis points to 1 percent, the second such increase this year.

The Bank's press release indicates that it made the move today in response to the steady flow of strong economic data, most notably the remarkably robust Q2 GDP numbers released last week. Earlier this year the Bank surprised markets by suggesting that the economy would reach effective full capacity by the end of this year.  Today's statement notes that GDP is now higher than the Bank had expected, which implies that we may already be almost at full capacity.  Although the Bank expects the pace of growth to slow in the second half of the year, and although it still sees some surplus capacity in the labour market, it clearly opted for an early move to avoid "falling behind the curve".

Remarkably, Canadian financial markets are now pricing in more tightening by the Bank than is currently priced in for the US Federal Reserve.  At least three more rate hikes are now expected, with one of them coming before the end of this year.  The Bank's release today is careful to note that further moves will be data-dependent, and there are at least two factors that should deter it from moving too quickly.

First, the economy's growth is heavily reliant on consumer spending, which makes up 64 percent of GDP.  Consumer debt, already at record levels, continues to grow, and it is hard to know the point at which even moderately higher rates might cause consumers to ease back on their spending.  Second, the prospect of higher rates is pushing the exchange rate ever higher: after this morning's announcement it spiked above 82 cents (US), its highest level in more than two years.  The Bank is anxious to see a higher level of export growth and will not want to see the currency strengthen unduly.

All of that said, more rate hikes are surely coming, with the next move probably in October.  The hand-wringing from financial experts about the problems that will be caused for households is already at a fever pitch.  Those of us old enough to remember a time when the Bank Rate was in double digits and rates would move around by a percentage point at a time can be forgiven if we feel slightly bemused by this.

The lonely goatherd (and shepherd and rancher)

Interesting article in the Sunday edition of the Toronto Star today, explaining how changing consumer demand is gradually leading corporations to reduce their investment in traditional livestock and focus instead on lab-created meats made from plant protein. This may well be the case, and you might suppose that it will be a great cause of rejoicing for groups like PETA, as well as fart-fretting environmentalists.

Except, of course, that if raising animals as a food source becomes a no-no, there may not be very many animals left to be treated ethically.  According to Statistics Canada, as of this past July 1 Canadian farmers owned 13 million head of cattle, 14 million hogs and about 600,000 sheep. Imagine that all "real" meat was banned starting tomorrow:  how many of those animals do you reckon would still be left alive by the end of this month?  Farmers aren't going to keep feeding animals they can't sell.  You can't release them into the wild, and there are far too many of them to put into zoos, even supposing that PETA and others would allow you to do that.

A world without animals raised as a source of food will be a world with a whole lot fewer animals. Is that an example of an unintended consequence?  I don't suppose this is news to PETA, but it's probably not something that has occurred to the majority of people.