Holiday pot pourri

Just a few thoughts as we wind down toward the new year...

* The US economy seems to be ending the year on a strong note, per this article from CNN.  The 2.1 percent annualized GDP growth rate originally reported for Q3 has been revised up to 2.3 percent, and modeling from the Atlanta Fed suggests a sharp acceleration to north of 7 percent for the final quarter.

Perhaps the most surprising stat in the CNN article is the news that US consumer confidence actually rose in December.  Evidently a lot of Americans are managing to avoid all of the hand-wringing over the omicron variant, with CNN very much in the forefront. It's very doubtful that confidence can remain high if hospitalizations and deaths start to mirror the rise in infections that omicron is driving. Q1 of 2022 looks likely to be a tough one for the economy, with the severity and duration of the slowdown almost entirely dependent on how omicron behaves. 

* The Canadian economy began the final quarter of the year on a strong note, according to one key indicator released by Statistics Canada today. Retail sales rose 1.5 percent in current dollar terms, or 0.9 percent in real terms, in the month of October.  Seven of the eleven sub-sectors posted gains, led by auto sales. StatsCan estimates that retail sale rose as further 1.2 percent in November. 

Just as in the US, the outlook for the Canadian economy is omicron dependent. Restrictions have been tightened across the country, most notably in Quebec, so it is very likely that the all-important retail sector will slow significantly in December and for at least the early part of 2022. (UPDATE, December 22: StatsCan reported today that real GDP rose 0.8 percent in October, and an estimated further 0.3 percent in November, which would bring GDP back within 0.1 percent of its pre-pandemic level. A strong GDP result for Q4 as a whole is just about locked in, but this tells us very little about how Q1/2022 will unfold).

* the lazy dog -- and on an entirely different note, the new Jane Campion movie, The Power of the Dog, appears to be the front-runner for the Best Picture Oscar. I watched this last weekend, and can only say, seriously?  The scenery is lovely and the acting is fine, but the pace is glacial. And the plot? Quite honestly, there's not nearly enough of that to fill a movie that runs more than two hours.

An interesting discussion of the movie by two critics can be found here on Slate. Warning: multiple spoilers! One of them liked it, while the other reacted to it much the same as I did. It's interesting that they agree that you really need to see it twice to figure out what happens. That set me thinking: do directors now feel free to make movies baffling because they assume just about everyone will watch via streaming rather than in a theatre, and can therefore watch as many times as needed to understand what they're watching? If so, that doesn't seem to me to be a good thing.

* Happy holidays! And finally, best wishes to all visitors to this blog for a safe and healthy holiday season. Hope to see you all again in 2022. 

Who's next?

The Bank of England, which wrong-footed markets by forgoing a rate rise in November,  today became the first major central bank to launch a tightening cycle, raising its target rate to 0.25 percent from the previous 0.1 percent. The move comes a day after the Federal Reserve gave clear indications that it expected to start raising rates soon, given the continuing recovery in the US economy. 

The Bank of England's move comes amid record daily COVID cases counts in the UK and extreme uncertainty over the possible impact of the omicron variant. Economic growth has recently slowed to a crawl in the UK, with GDP still about 0.5 percent below its pre-pandemic peak.  However, the Bank's focus is firmly on the buildup of inflationary pressures. CPI is already rising at a 5.1 percent rate, and the Bank expects it to reach 6 percent in the next few months. 

It is far from clear that the Bank's action will have any direct impact on inflation in the near term. Much of the current price pressure in the UK, as elsewhere, is related to supply chain issues. These may have been exacerbated by Brexit, but they are not something that can be addressed by raising rates. It seems likely that the Bank is looking to head off higher inflation expectations before they can take firm hold; memories of the double digit inflation rates of the 1970s may still lurk not far beneath the surface of public consciousness. 

No central bank starts a rate hike cycle thinking that one move will be all that is needed. However, the uncertainty over omicron means that today's move may indeed be "one and done", at least for the next several months.  This analysis from an article in The Guardian sounds right:

Hannah Audino, an economist at the accountancy firm PwC, said speculation the Bank would embark on further rate hikes in the spring could be wide of the mark.

“With [Covid-19] cases at record levels and expected to continue rising, the risk of further social distancing measures, and signs that business confidence is already weakening, it is likely this modest rate rise could be the first and only one for some time.”

Moving on to the US, we find that the Federal Reserve is continuing to clear the decks for a rate hike by accelerating the taper of its quantitative easing bond purchases. It is reducing its purchases by an aggregate of $30 billion per month ($20 billion for Treasuries and $10 billion for MBS), starting in January, with indications of similar-sized reductions after that. If this actually happens, new QE purchases would fall to zero before the end of Q1/2022. 

The Fed continues to stress that "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."   However, the detailed economic and financial projections that accompany the FOMC statement reveal that its base case expectation is that it will raise rates by 75 basis points in 2022 and by a further 75 basis points in 2023. 

Some of the same caveats as in the UK apply equally in the US. It is not clear that the current inflationary pressures that have carried US headline CPI above 6 percent can be addressed by raising interest rates. That said, however, the growth outlook for the US, even in the face of omicron, looks considerably more robust than that for the UK. So expect the Fed to be the next to jump, probably by April, and for there to be more than one move in fairly short order. 

Deficits and inflation

On Tuesday, Canada's Finance Minister Chrystia Freeland tabled the Government's Fall Economic and Fiscal Update. Briefly summarized, the update shows that the fiscal situation is somewhat more favourable than was projected in the 2021 budget back in the Spring -- and that fact, together with the recent worsening in the COVID outlook, is giving the Government cover for further spending increases.

Final figures for the 2020-21 fiscal year (which ended this past April) show a deficit of C$ 327 billion, materially lower than the C$ 354 billion estimated on budget day.  The improvement is roughly equally attributable to higher-than-expected income tax revenues and lower program spending.  For the current fiscal year, the projected deficit is C$ 144 billion, down from C$ 155 billion projected on budget day. It's worth noting, however, that without the package of new spending items announced in the update (under the clumsy umbrella of "Protecting our recovery by finishing the fight against COVID-19"), the deficit projection would have been closer to C$ 130 billion. 

The deficit is projected to continue falling in medium term, hitting C$ 58 billion in 2022-23 and reaching C$ 13.1 billion by 2026-27. It need hardly be stated that the data for the "out years" of the forecast are little more than aspirational -- if even that. Still, one positive the Government can point to is that the debt/GDP ratio may fall rather faster than earlier expected. It is now projected to peak at 48.0 percent in the current fiscal year, down from 51.2 percent projected back on budget day, and should slip to about 45 percent by mid-decade.

Despite cries of anguish from opposition politicians (of which, more later), it is hard to be surprised by the tack the Government is taking here. For now it can project a falling deficit while still spending more money for the fight against COVID, including a C$ 4.6 billion contingency to deal with the omicron variant.  The political calculus is that there is little appetite among voters for an early bout of austerity. Keep in mind that this is a minority Government, and recall that when Justin Trudeau was asked before the October election if he would commit to not calling an early election if he wound up with another minority, he simply said "Politics doesn't work like that". Until further notice, every decision and statement must be seen in a pre-election context. 

Even though this is a mid-year fiscal update and not a budget, the opposition Conservatives are taking the opportunity to try to focus on their overriding theme du jour: inflation is Canada's biggest problem, and it's all Justin Trudeau's fault. The Tories' belligerent finance critic, Pierre Poilievre, was on his feet soon after Freeland completed her speech, reciting a formulation I have not heard in many years: Canada's current inflation spike is caused by "too much money chasing too few goods", and the reason there is too much money is, of course, Trudeau and Freeland's addiction to deficit spending.

So it's timely that this morning saw the release of the latest consumer price inflation data*, for the month of November. The numbers are not good, but they remain a whole lot better than what's happening south of the border. CPI rose 4.7 percent year-on-year, the same rate as was seen in October. All eight major sub-components of the index rose in the month, led by a 10 percent rise in transportation costs, mainly resulting from a 43 percent jump in gasoline prices. Excluding gasoline, CPI rose 3.6 percent in the year to November, matching the rise posted in October.

The month-on-month increase in CPI slipped to 0.2 percent, down from 0.7 percent in October. However, there was no evidence of any decline in the Bank of Canada's three preferred core inflation measures, so we will be waiting a while longer for any real evidence that the inflation spike is "transitory".

StatsCan has, shall we say, a rather more nuanced view of the causes of inflation than Pierre Poilievre does. As regards gasoline prices, it notes that "Oil production continues to remain below pre-pandemic levels, though global demand has increased".  For grocery prices, which rose at the fastest pace in six years, it draws attention to "higher shipping costs and supply chain disruptions" as well as "poor crop yields resulting from unfavourable weather conditions". Not much that Trudeau and Freeland, not to mention the Bank of Canada, can do about any of that, but it would be unwise to hold your breath waiting for Poilievre to change his tune. 

* Link to the website is not available at the time of writing because of cybersecurity concerns at StatsCan. 

Mandate update

The Bank of Canada has based its policy decisions on an inflation target since 1991. It looks to keep inflation within a 1-3 percent control range, with a target at the 2 percent midpoint, over time.  Every five years, the Bank and the Government meet to discuss and update this mandate. Today a revised version  was announced, replacing the existing framework which is set to expire at the end of this month. The new mandate will run until the end of 2026.

The most important past of the announcement is that the existing target range will remain the Bank's primary policy goal, with the Government's full approval:   "The Government of Canada and the Bank of Canada believe that the best contribution of monetary policy to the well-being of Canadians is to continue to focus on price stability."    That said, however, it is clear that maintaining employment is now an important and explicit secondary goal for the Bank: "The Government and the Bank also agree that monetary policy should continue to support maximum sustainable employment, recognizing that maximum sustainable employment is not directly measurable and is determined largely by non-monetary factors that can change through time."

The increased emphasis on employment has in effect been telegraphed by the Bank in its recent policy decisions, which have seemed to put greater weight on the uncertain growth outlook than the persistence of above-target inflation. In that sense, it is not obvious that the new mandate will drive any immediate change in the Bank's policy stance. It is interesting to note, however, that what we might call the small print of the new mandate makes several references to the "flexibility" provided by the 1-3 percent range and states that  "The Bank will explain when it is using the flexibility in the framework."  

One wonders if at some time in the next five years, a Finance Minister might be tempted to ask the Bank why it is not using that flexibility. Still, this is a less radical overhaul of the mandate than some analysts might have feared, and the repeated references to the primacy of the inflation target should be reassuring to markets.

Today's announcement marks the start of a busy week for Finance Minister Chrystia Freeland. On Tuesday she switches her focus from monetary policy to fiscal policy, delivering the Government's Fall economic and fiscal update. Stay tuned.  

Whistling past the graveyard*

Fed Chair Jerome Powell may have sworn off describing the current level of inflation as "transitory", but his boss President Biden is still singing from the old hymnbook. Biden's response to the US CPI data for November that were released this morning shows that he realizes that the soaring cost of living is very much top of mind for American voters, seemingly overriding the feelgood effects of strong GDP growth and rising employment.

The raw numbers released by the BLS are startling, even if they are broadly in line with market expectations. Headline inflation rose 6.8 percent year-on-year, the highest print since June 1982,  when Paul Volcker was Fed Chair.  A 58 percent leap in gasoline prices was the most conspicuous contributor to the headline number. However, even stripping out volatile food and energy prices, year-on-year core CPI stood at 4.9 percent, its highest level since 1991 and obviously way above the Fed's comfort level.

President Biden's reaction smacks ever so slightly of desperation, not least in the fact that he tried to get his retaliation in early by speaking out before the data were officially released:  "Tomorrow, we will get a report on consumer prices that experts expect to be elevated again, driven in part by energy prices and used car prices. Fortunately, in the weeks since the data for tomorrow's inflation report was collected, energy prices have dropped. The price of gas at the pump has already begun to fall nationally, and real pump prices in 20 states are now lower than the 20-year average."

Well, maybe, but basing one's forecast on literally three weeks of anecdotal data seems very unwise. If you just want to look at recent data, here's another take. The monthly rise in headline CPI was 0.8 percent in November, versus 0.9 percent in October. So for those two months what we might call the running rate of inflation was edging into double digit territory. For core CPI the numbers are a little less extreme, but still annualize to something like 6 percent, suggesting that this more reliable measure still has further to rise, whether President Biden likes it or not. 

The FOMC's final meeting of the year is set for Tuesday and Wednesday next week (December 14-15). It should be a lively session. There is every reason for the Fed to accelerate its QE taper strategy and strike a clearly hawkish tone on the likely timing of rate hikes. Failure to get ahead of inflation risks a return to the Volcker era, which is surely something nobody wants.

* Yes, I know I have used this title before, more than a decade ago and in a very different context. My blog, my rules. 

It's coming (and so is Christmas)

Ahead of today's Bank of Canada Governing Council meeting, markets had begun to contemplate the possibility that the Bank's first rate hike might come as early as the first quarter of 2022.  The Bank has firmly put paid to any such expectations, with today's press release striking a surprisingly dovish tone and reaffirming the Bank's expectation that the tightening cycle will not begin until "the middle quarters" of next year.  

Market expectations for an earlier rate hike seemed well-founded, based on the latest economic data. The economy grew at a 5.5 percent annualized rate in Q2; employment grew by a remarkable 154,000 jobs in November, regaining all the losses caused by the pandemic; and inflation has been steadily rising throughout the year, reaching a multi-decade high of 4.7 percent in October. 

Despite these developments, the Bank believes that the economy "continues to require considerable monetary policy support". While admitting that the economy showed considerable momentum at the start of Q4, it argues that the omicron COVID variant and the devastating floods in British Columbia could weigh on growth, mainly by exacerbating supply chain disruptions. Concerns about omicron seem to wax and wane almost on a daily basis, while the impact of the BC floods is ambiguous at best. Arguably, the massive reconstruction efforts already under way could actually boost GDP growth in Q1 and beyond. 

As for inflation, the Bank remains convinced that the recent spike will prove transitory. It notes that gasoline prices, a major driver of recent increases in CPI, have recently eased, partly in response to the emergence of the omicron variant. It says core measures of inflation "are little changed since September", which seems a very small sample size to be relying on. It expects CPI to remain elevated through the first half of 2022 and to "ease back towards" 2 percent in the second half of the year. That form of words seems carefully chosen to cover the possibility that even if it begins to ease, CPI may remain above target all  through next year. This is surely not what the Bank had in mind when it first used the term "transitory". 

The Bank is taking a risk here. Taken at face value, the recent data on both growth and inflation seem to cry out for an early policy response.  The 2 percent inflation target has been the pillar of the Bank's policy approach for nigh on three decades. It is tempting to speculate that the approach it is now taking points to a broadening of its policy mandate, which is is set to be renewed almost any day now. 

UPDATE, December 9: This new report predicts that Canadians' food bills will rise 5-7 percent in 2022. Meanwhile it looks as if gasoline prices are on the rise again, after a brief fall triggered by the arrival of the omicron variant. Given the importance of these two items in most households' budgets, these trends will make it very difficult for the Bank of Canada to keep inflation expectations in check.

Wow!

The headline numbers for Canada's employment report for November, released today by Statistics Canada, are simply extraordinary.  The economy added 154,000 jobs in the month, against a market expectation of about 35,000. This means that employment is now 185,000 higher than its pre-COVID peak. The unemployment rate plunged 0.7 percentage points to 6.0 percent, with the continuing growth in the labour force keeping it just above its pre-pandemic level of 5.7 percent. 

Details of the report are generally positive. Full-time work accounted for just over half of the gains, or 80,000 jobs; this helped to increase total hours worked by 0.7 percent in the month, bringing this measure back to its pre-pandemic level. The bulk of the gains in employment came in the private sector, which added 107,000 new positions in the month.  The services sector accounted for 127,000 jobs, while the goods-producing sector, which has been losing jobs in recent months, added 26,000 positions. Lastly, the gains were well distributed across the country, with six of the ten Provinces reporting higher employment. 

StatsCan's commentary on its labour market data has become increasingly lengthy in recent times, and  this month's report provides some important insights into the changing nature of the employment market. Once again the agency points out that while the number of jobs requiring post-secondary education has risen by 490,000 (or 12 percent) over the past two years, jobs requiring a high school diploma or less have fallen by 150,000. A high reported level of job vacancies and a falling unemployment rate among the latter group suggests that employers are finding it difficult to find workers to fill such positions, an impression that certainly matches anecdotal evidence in most parts of the country. 

StatsCan's characterization of the overall state of the labour market is worth quoting at length:

....labour markets increasingly resemble those observed since the summer of 2019, when Canada's unemployment rate fell to a record low, average wages increased after a prolonged period of little growth, and job vacancies ticked upwards. These conditions are likely to contribute to new or worsening imbalances in provincial, regional and local labour markets, including shortages of specific skills, or geographic mismatches between vacant positions and available workers with the skills to fill them.

This all sounds very positive, but there is now a potentially very dark cloud on the horizon, in the shape of the new omicron COVID variant.  The November survey data, on which today's report is based, were collected before omicron began to dominate the news feeds. It is still too soon to draw any conclusions about the severity of the new variant or its likely impact, although that doesn't seem to be inhibiting the media from attempting to stir up panic. With or without omicron, however, the perennial volatility of Canada's employment data makes it a safe bet that the numbers for the next month or two will fall well short of the remarkable numbers released today.