But can it last?

After contracting marginally in the second quarter of the year, Canada's real GDP rebounded strongly in the third quarter. Data released today by Statistics Canada show that real GDP rose 1.3 percent in the quarter, or about 5.4 percent at an annualized rate, well ahead of market expectations. Early indications are that the strong pace continued into the current quarter, but obviously the new COVID variant will have something to say about whether that can last. 

With COVID restrictions easing, it is no surprise to find that household spending was responsible for much of the growth in Q3. Spending on both semi-durables and services rose sharply: by 14 percent and 6.3 percent respectively. This was partly offset by a 1.4 percent fall in spending on durables. StatsCan attributes this to ongoing supply chain issues, which "constrained demand and spending". Some analysis from business economists suggests it may have been an outright lack of product to buy -- notably  automobiles -- that held durables spending down, rather than simply price considerations. 

The other main source of growth in Q3 was the trade sector. Real imports fell -- those supply chain issues again -- but exports were 1.9 percent higher in volume terms. The increase in exports was largely driven by shipments of crude oil to the United States, as the Alberta oil patch enjoys one of its periodic booms. 

StatsCan also provided monthly GDP data for September and an early estimate for October.  Growth was a scant 0.1 percent in September, with notable weakness in goods-producing sectors. However, it appears to have bounced back sharply to an estimated 0.8 percent in October, as manufacturing recovered strongly. 

It seems likely that growth remained robust in November, which all but ensures a strong result for Q4 as a whole. However, the emergence of the new omicron COVID variant at the very end of the month may weigh on the outlook for December and the early part of 2022. That said, the Canadian economy has shown improved resilience as each stage of the pandemic has unfolded, so it is not yet clear that this latest setback will have a severe economic impact. 

In the meantime, the next big event on the data docket comes this Friday, with the release of November employment data. The consensus (never reliable for this very volatile series) looks for the addition of another 30,000 or more jobs, pushing the unemployment rate closer to pre-pandemic levels. Long may the good news continue -- we need a break!

Oil spill

According to the American Automobile Association (AAA), some 48 million American drivers will hit the highway over the next few days for Thanksgiving weekend. They'll be filling up the tank at the highest prices in seven years, averaging close to $3.50/gallon nationwide but considerably higher than that in some states, such as California. The real economy is doing just fine -- check out the remarkable jobless claims data released today -- but the rising cost of gasoline (and just about everything else) is top of mind for voters, and largely accounts for President Biden's plummeting approval ratings. 

So it's no surprise that the President wants to provide some relief at the pumps. There have been rumours going around for a while about a possible release of supplies from the Strategic Petroleum Reserve, and this has now come to pass. Over the next while, the US will release 50 million barrels of crude from the reserve, and has secured agreement from other countries, including China, the UK, Japan, and South Korea, to do the same thing, albeit on a much smaller scale.

To which one can only say: seriously, folks? Global oil production is somewhere in the area of 90-100 million barrels per day. (It peaked at 95 million in 2019, fell sharply in 2020 but is now presumably rising again as the global economy bounces back}.  It seems pretty far-fetched to imagine that releasing the equivalent of less than one day's production will stem the upward pressure on prices, let alone reverse it. 

Indeed, as numerous commentators have already pointed out, it could even have a perverse effect. OPEC (and OPEC+, which includes Russia) is understandably ecstatic at the way prices have moved this year. There is every possibility that these countries will react to Biden's move by limiting their own production, in order to keep prices where the are, or even boost them further. 

It's no real surprise that Biden feels the need to "do something" when this issue is so important to voters, and the mid-term election campaigns are about to ramp up. But empty gestures can be dangerous, and this gesture is about as empty as it gets. 

"Transitory but not short-lived"

 Last week, Bank of Canada Governor Tiff Macklem told a reporter that the Bank sees the current uptick in inflation as "transitory, but not short-lived". He added that "I think transitory to economists means, sort of not permanent".  I can't say I remember spending much time in economics classes debating the meaning of that word, but I am reasonably sure that Macklem's current definition is not what he had in mind when he first used the term. I'm even more certain that it's not the message most Canadians thought they were hearing either. 

Today's report from Statistics Canada on consumer prices for October underscores why Macklem (like Fed Chair Powell) is hastily revising the lexicon. Headline CPI rose 4.7 percent in the year to October, up from the 4.4 percent rise recorded in September. The increase was in line with expectations, but serves to bring CPI to its highest annual increase since 2003. On a seasonally adjusted basis, CPI rose 0.5 percent month-over-month, which means that what we might call the running rate of inflation is not slowing. 

The transportation component of the index remains the largest contributor to the overall increase, rising 10.1 percent year-on-year, propelled by a 25 percent rise in energy prices. However, inflation is broad-based, with all eight major sub-components of the index higher than last year. Excluding energy, the increase in CPI was 3.3 percent, the same pace as in September; excluding both food and energy (the normal definition of core CPI), the annual increase was 3.2 percent.

If there is any small consolation for the Bank of Canada in this report, it lies in the three "special aggregates" the Bank uses to monitor underlying inflation trends. These indices have been grinding slowly higher all year, but in October all three recorded exactly the same year-on-year rise as in September. Even so, the mean rise in these measures, at 2.7 percent, is well above the Bank's 2 percent target.

Looking ahead, there is anecdotal evidence that the rise in gasoline prices at the pumps has stalled. However, supply chain pressures persist, and may be dramatically worsened by the impact of the disastrous flooding in British Columbia this week. Governor Macklem has hinted that the Bank is edging closer to raising rates.  The first move is likely to come around the end of the first quarter of 2022. 

What to do?

Even with everyone and their dog braced for higher inflation, today's US CPI print for October was a shocker.  Headline CPI rose 6.2 per cent from a year ago, the biggest year-on-year gain since 1990.  Although the focus has mainly been on energy and food costs, the report makes it clear that inflation pressures are much more widespread than that. Core CPI, which excludes both of those categories, rose 4.6 percent. Nor is there any consolation in the month-to-month figures: headline CPI rose 0.9 percent in October alone, with core up 0.6 percent. Both of these numbers were higher than in September, and both annualize to much higher rates than the yearly numbers reported today. 

It's easy to revive the old monetarist shibboleths here: "inflation is always and everywhere a monetary phenomenon", and "too much money chasing too few goods".  Needless to say, those points are already being trotted out, but the situation is a lot more complicated than that. It's well and good to point to the massive stimulus package launched last year in response to the pandemic during the Trump administration, but it is hard to argue that providing much less stimulus would have led to a better outcome. Most likely the US would now be facing a severely depressed economy, with few tools at its disposal to get things moving again.

That said, the data do cast some doubt on the wisdom of the Biden administration in pushing for yet more stimulus, in the shape of the infrastructure bill and the still-pending Build Back Better package. There is no doubt that part of the current inflationary surge stems from the demand side of the economy, as reopening of the economy induces Americans to spend the cash they accumulated earlier in the pandemic.

In Canada, Finance Minister Chrystia Freeland  described unspent COVID benefits as "pre-loaded stimulus".  Although US support programs were smaller than Canada's, the same logic applies there, and would seem to suggest that the economy is rapidly getting back on track without the need for further government stimulus. 

It is, of course, the supply side that has been receiving most of the attention for media and economists alike as the primary driver of inflation. The examples are legion, ranging from a semiconductor shortage that is cutting auto production, to wide-ranging problems in the supply chain itself (shortages of shipping containers and truckers), to inadequate production of oil and gas as economies recover from the COVID-induced collapse in demand.

In the light of history, it's not surprisingly that President Biden seems likely to focus on this last item. Fresh from lecturing the world at COP26 just over a week ago, he is demanding that OPEC ramp up its oil output in order to save Americans from pain at the pumps, an appeal that has so far fallen on deaf ears.  He also seems to be mulling the possibility of releasing oil from the Strategic Petroleum Reserve in Louisiana, though that's hardly the purpose for which the Reserve was established. 

If the White House can't do much to help (and may even be adding to the problem with its stimulus plans), it falls to the Federal Reserve to try to get inflation back under control.  Governor Jerome Powell's pledge to allow inflation to remain above the 2 percent target in order to foster economic recovery always seemed a little foolhardy, but we can hardly expect him to morph into Paul Volcker and start pushing rates through the roof.

Nor is it clear that he should. Raising rates might put something of a crimp into the demand side of the inflation problem, but that may soon calm down anyway as the savings built up earlier in the pandemic get spent. And there's no reason to think that higher rates would do anything to help ease supply chain pressures, many of which originate outside the United States.

This is not to say that the Fed can just sit on its hands. Powell's description of inflation pressures as "transitory" is looking more ill-advised by the day, but the forces behind those pressures are not easily addressed by monetary policy. The risk for the Fed is that inflation expectations start to move way above its 2 percent target. Movements in fixed income markets suggest that is starting to happen, and that is something the Fed can address. The lethargic pace of tapering QE may well have to be stepped up in short order, and Chairman Powell's rhetoric is going to have to become a whole lot more hard-edged. 

The situation is nowhere near as dire as in the 1980s, but both Governor Powell and I lived through that era, and I think he would agree that we don't want to go back there. Over to you, Jay!

Good but not great

In September Canadian employment finally returned to its pre-pandemic level. Data released today by Statistics Canada show that employment rose further in October, albeit at a slower pace. The economy added 31,000 jobs in the month, pushing the unemployment rate down by 0.2 percentage points to 6.7 percent. This is the lowest jobless rate since the pandemic began, but is still a full percentage point above the pre-pandemic rate.

The employment gains were entirely accounted for by private sector jobs, which rose by 70,000 in the month. This was offset by a fall of 38,000 in the number of self-employed individuals; this is always a volatile series, but it is striking to learn that self-employment is almost 10 percent below its pre-pandemic level and stands at its lowest point since 2007. Full-time work accounted for most of the month's gains; full-time employment for both males and females is now back to pre-COVID levels.  

In terms of sectors, the strongest gains were seen in retailing (up 72,000), offset by a slightly puzzling decline of 27,000 in accommodation and food services. Employment in the goods producing sector remains largely stagnant and is more than 130,000 lower than its pre-pandemic level.  The regional breakdown shows strong job gains in Ontario but Alberta and Saskatchewan, which have coped less well with the latest surge of COVID, both shed jobs in the month.

As always there are some interesting nuggets buried in the report that shed further light on the underlying health of the jobs market: 

• Total hours worked rose 1 percent in the month, but are still 0.6 percent below their February 2020 level. 
• The number of persons working less than half their usual hours fell by 100,000 (or 9.7 percent)  in the month but is still 14.5 percent above its pre-COVID level. 
• Almost 24 percent of employed Canadians continue to work from home. 
• Almost 28 percent of those unemployed are considered to be long-term jobless, a figure that shows little sign of improving. 
• The labour force underutilization rate fell by 0.7 percentage points to 13.1 percent in the month. 

One significant surprise: it appears that the Great Resignation supposedly underway in the United States is not being replicated in Canada.  Canada's participation rate is only 0.3 percentage points lower than in February 2020, while the comparable rate in the US is 1.7 percentage points lower. The clumsily-named job-changing rate was 0.7 percent in October, right in line with its 2016-2019 average. 

All in all the report seems to show there is still considerable slack in Canada's job market. Wages growth is also reasonably tame: StatsCan estimates that in the two years from September 2019 to September 2021, hourly wages rose 5.1 percent, barely outpacing the 4.9 percent rise in CPI over the same span. (It would be hard to find more than one Canadian in a hundred who would believe this)! These numbers will provide some short-term comfort for the Bank of Canada, but the near-ubiquitous anecdotal (as opposed to statistical) evidence of labour shortages seems certain to put upward pressure on wages in the months ahead.

Ontario's pre-election budget update

 Ontario's Finance Minister, my former colleague Peter Bethlenfalvy, tabled the Province's customary Fall economic statement and budget update today. With a Provincial election coming in June 2022, there were widespread expectations that the update would include tax cuts for individuals and corporations, one promise from the last election that the Ford government has not yet delivered. As it turned out, the budget update was largely a rehash of the last full budget, which was tabled in March. Perhaps Ford and Bethlenfalvy are holding back the tax cuts for a real pre-election giveaway in the Spring.

The statement repeats promises to build a couple of new highways on the outskirts of Toronto, a vote-rich area that the Tories need to rely on to deliver them an electoral majority. There is some additional funding for the health care sector, including long-term care.  The Province is also preparing to scale back its COVID-specific funding, which will fall from more than C$ 10 billion this fiscal year to $3.4 billion in 2022-23 and zero the year after that. 

The one intriguing statistic in the report, and the one that may offer the Tories two distinct choices as they seek to win next year's vote, is the deficit projection. The shortfall for the current fiscal year (to March 2022) is now set at $21.5 billion, down from the $33 billion projected in the March budget. This is attributed in large measure to a rebound in tax revenues as the Provincial economy has recovered from the pandemic.

Come election time, the Tories can spin this as evidence that they are good economic managers and offer the voters more of the same if they are re-elected: this would certainly be the old-school Tory approach. Or they can say that their success in getting the deficit under control gives them room to introduce targeted tax cuts, bribing the electorate with its own money in the time-honoured way. The fact is, it's not a bad choice to have, if you're Doug Ford. He may not have been a great Premier for the Province, but come June the opposition parties might find it very hard to dislodge him. 

Here comes the taper

It has to be said that the language of FOMC policy decisions is becoming ever more convoluted. In keeping its funds target range unchanged at 0-0.25 percent today, it expressed its stance this way:

"The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. With inflation having run persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer‑term inflation expectations remain well anchored at 2 percent. The Committee expects to maintain an accommodative stance of monetary policy until these outcomes are achieved. The Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and expects it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee's assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time".

It is, of course, always the case that policy decisions reflect the judgment of FOMC members; there is no mechanistic formula. Still, wording such as "levels consistent with the Committee's assessments of maximum employment" and the double use of the phrase "for some time" do not exactly provide much guidance for financial markets. Elsewhere in the statement, the Fed says that "Inflation is elevated, largely reflecting factors that are expected to be transitory."  The clear impression is that the FOMC is still feeling its way along here, which is perhaps inevitable in present circumstances. 

There is one important change, however: the taper is on. The Fed is now setting out a clear path for the winding-down of its asset purchase programs. Purchases of Treasuries will be cut by $10 billion per month and mortgage-backed securities by $5 billion per month, starting almost immediately, and a further reduction of the same size will take place in December.  The FOMC expects to continue reducing purchases by similar monthly amounts after December, if conditions allow. 

Since an end to net asset purchases seems like a precondition for rate hikes, this suggests that a tightening cycle cannot begin until mid-2022. Whether the "transitory" inflation pressures will still be around by then is something we shall just have to wait and see.