Wrong, wrong, wrong

Your esteemed blogger has plenty of experience of calling central bank actions incorrectly, but two in one day may represent an unwanted first. Neither the Bank of Canada nor the Fed delivered rate hikes today, so I got that wrong -- but so, in my considered opinion, did the Bank and the Fed. 

The Bank of Canada got the ball rolling this morning, keeping its overnight rate target unchanged at 0.25 percent. Given recent, more hawkish signals from the Bank, markets had placed about a 70 percent probability on a rate increase today. Indeed, the Bank's press release could have been used almost unchanged if it had in fact announced a rate hike, which may be an indication that this was a very close-run decision. In contrast, arguments against an early move are very thin on the ground. Consider: 

" In Canada, GDP growth in the second half of 2021 now looks to have been even stronger than expected. The economy entered 2022 with considerable momentum, and a broad set of measures are now indicating that economic slack is absorbed. With strong employment growth, the labour market has tightened significantly. Job vacancies are elevated, hiring intentions are strong, and wage gains are picking up. Elevated housing market activity continues to put upward pressure on house prices.

The Omicron variant is weighing on activity in the first quarter. While its economic impact will depend on how quickly this wave passes, it is expected to be less severe than previous waves.... After GDP growth of 4½ % in 2021, the Bank expects Canada’s economy to grow by 4% in 2022 and about 3½ % in 2023.

CPI inflation remains well above the target range and core measures of inflation have edged up since October. Persistent supply constraints are feeding through to a broader range of goods prices and, combined with higher food and energy prices, are expected to keep CPI inflation close to 5% in the first half of 2022.... Near-term inflation expectations have moved up, but longer-run expectations remain anchored on the 2% target."

Plenty of evidence to support a rate hike there, and the sentence immediately following that extract should have sealed the deal: "....Governing Council judges that overall slack in the economy is absorbed, thus satisfying the condition outlined in the Bank’s forward guidance on its policy interest rate."  Rate hikes are clearly imminent -- "Governing Council expects interest rates will need to increase" -- so, given the tone of the release and the fact that markets were primed for a move, the only real mystery is why the Bank did not choose to start the tightening cycle today. 

Down in DC, and facing even higher inflation than Canada's, Fed Chair Jerome Powell had sounded unmistakably hawkish in recent weeks. Back on January 11, Powell told the Senate Banking Committee that “If we have to raise interest rates more over time, we will .....We will use our tools to get inflation back.” Despite this, market expectations were not pointing to a rate hike at today's FOMC meeting. And indeed, the FOMC kept rates unchanged today, even as it issued a press release that, like the Bank of Canada's, could equally have been written to support a rate move:

"Indicators of economic activity and employment have continued to strengthen. The sectors most adversely affected by the pandemic have improved in recent months but are being affected by the recent sharp rise in COVID-19 cases. Job gains have been solid in recent months, and the unemployment rate has declined substantially. Supply and demand imbalances related to the pandemic and the reopening of the economy have continued to contribute to elevated levels of inflation. Overall financial conditions remain accommodative, in part reflecting policy measures to support the economy and the flow of credit to U.S. households and businesses. 

The path of the economy continues to depend on the course of the virus. Progress on vaccinations and an easing of supply constraints are expected to support continued gains in economic activity and employment as well as a reduction in inflation. Risks to the economic outlook remain, including from new variants of the virus. 

....With inflation well above 2 percent and a strong labor market, the Committee expects it will soon be appropriate to raise the target range for the federal funds rate."

Why the hesitancy, in both Washington and Ottawa?  The Fed can at least make the case that it has not yet finished tapering its QE program, though it expects to do so by the beginning of March; the Bank of Canada has already ended its program. Do geopolitical uncertainties, mainly regarding Ukraine, weigh heavier in central banks' calculus than soaring oil prices and the risk that rising inflation expectations will become embedded?  It seems unlikely.

Have both the Fed and the Bank been spooked by the gyrations in markets in recent days?  It is hard to separate out how much those gyrations may have been driven by geopolitical factors and how much represents a delayed "taper tantrum".  However, if both central banks were looking to avoid creating extra uncertainty, holding back on a rate move when one had been so clearly telegraphed is surely not the right way to do it. It simply prolongs the markets' anxiety until the next rate decision day. It says here that both the Fed and the Bank of Canada missed an opportunity today, something they may come to regret. 

When you gotta go, you gotta go

Canada's headline consumer price index ticked up to a fresh 30-year high in December, according to data released by Statistics Canada this morning.  The year-on-year rate stood at 4.8 percent, up from 4.7 percent in November. All eight components tracked by StatsCan were higher year on year, although -- in what just might be a positive sign of things to come -- seven of the eight actually fell from November to December.  

Food, shelter and energy prices continue to lead the gains. Food prices were up 5.2 percent from a year ago, led by higher prices for imported fresh produce, which StatsCan attributes in part to supply chain disruptions.*  The shelter index rose 5.4 percent, with increased insurance costs adding to the upward lift from low interest rates. Energy costs rose 8.9 percent, led by a 33 percent rise in gasoline prices, although it should be noted that gasoline actually declined in price from November to December. Excluding food and energy, the year-on-year rise in CPI was 3.4 percent. 

The fact that the upward pressure on inflation is being led by food, shelter and energy is significant for policymakers. These are the daily/weekly/monthly costs that quite literally hit people where they live. Even if supply chain disruptions start to ease this year,  there is a clear risk that the increase in these categories, which most people already think is much higher than the official data suggest, will serve to boost inflation expectations, an outcome the Bank of Canada is very anxious to avoid.

The Bank's three preferred measures of core inflation are also sending a cautionary message. All three moved higher in December. One of these, CPI-trim, now stands at 3.7 percent, above the CPI ex food and energy figure of 3.4 percent, and the average of the three indices is just below 3 percent.  

Both the Bank of Canada Governing Council and the Fed Open Market Committee meet next week, with rate announcements set for January 26. Canadian markets are pricing in about a 75 percent likelihood of a 25 basis point rate hike this month, and the odds of an identical move by the Fed must also be high. For both central banks, this is likely to be the first step in a tightening cycle that will see at least four hikes by the end of this year.

* I can report on the basis of a visit to our local independent food emporium this morning that there is no evidence of any gaps on the shelves, despite scare stories in the media. Gigantic Mexican eggplant and zucchini abound. 

As bad as expected

US all-items CPI rose 7.0 percent year-on-year in December, up from the 6.8 percent gain posted in November. The increase was in line with market expectations and marked the highest rate of increase in consumer prices since June 1982.  Stripping out volatile food and energy prices, the December figure was better but by no means good: that measure rose 5.5 percent in the year, up from 4.9 percent in November, its biggest annual rise since February 1991.  

If there is any good news at all in this report, it lies in the fact that the monthly rise in the all-items index, at 0.5 percent, was well below the outsize gains seen in Both October and November.  However, this will provide no comfort to policymakers at the Fed.  The decline in the all-items figure largely resulted from a monthly decline in the energy component, with both gasoline and natural gas prices easing in the month. There are already clear signs of energy prices, notably for natural gas, heading higher in January.

The calculation of the year-on-year index will also work against any early easing of perceived inflation pressures. All-items CPI rose only 0.3 percent and 0.4 percent in January and February 2021 respectively. If the monthly gains in the first two months of this year match December's 0.5 percent -- and the actual outcome may well be higher -- the year-on-year rise in headline CPI will reach 7.5 percent as last year's lower readings fall out of the calculation. It is only in Q2 that this "base effect" could start to edge the annual figure lower. 

The Fed cannot wait around for that to happen.  No doubt Chair Jerome Powell had advance knowledge of the December CPI data when he appeared before Congress yesterday. Market expectations have been focused on a possible rate hike at the March 15-16 FOMC meeting, when the Fed is set to release its updated economic forecasts. However, there is a much earlier FOMC meeting than that: January 25-26. Given today's data, the tone of Powell's testimony and the increasingly urgent need to curb inflation expectations, the start of the tightening cycle may be just a couple of weeks away. 

Four more years!

Fed Chair Jerome Powell has spent his day in a nomination hearing before the Senate Banking Committee, which has to decide whether to ratify President Biden's recommendation to grant him a second four-year term in the job. The process allows Powell to set out his version of his accomplishments to date, as well as allowing Senators an opportunity to pick holes in his record. Despite some strong criticism, largely from the Republican side, confirmation is all but certain.  

Powell's opening statement understandably focuses on the unprecedented challenges the Fed has faced as a result of the COVID pandemic. He credits both the Fed's actions and those of Congress with making the impact of the pandemic much less severe than it could have been, and with setting a strong recovery in train: 

"The initial contraction was the fastest and deepest on record, but the pain could have been much worse.

Congress provided by far the fastest and largest response to any postwar economic downturn. At the Federal Reserve, we used the full range of policy tools at our disposal. We moved quickly to restore vital flows of credit to households, communities, and businesses and to stabilize the financial system.

These collective policy actions, the development and availability of vaccines, and American resilience worked in concert, first to cushion the pandemic's economic blows and then to spark a historically strong recovery."

Looking ahead, Powell emphasizes both the Fed's commitment to its inflation target and its pursuit of a stable financial system:

"We know that high inflation exacts a toll, particularly for those less able to meet the higher costs of essentials like food, housing, and transportation. We are strongly committed to achieving our statutory goals of maximum employment and price stability. We will use our tools to support the economy and a strong labor market and to prevent higher inflation from becoming entrenched.....

Over the past four years, my colleagues and I have continued the work of our predecessors to ensure a strong and resilient financial system. We increased capital and liquidity requirements for the largest banks—and currently, capital and liquidity levels at our largest, most systemically important banks are at multidecade highs......

We also updated our monetary policy framework, drawing on insights from people and communities across the country, to reflect the challenges of conducting policy in an era of persistently low interest rates."

Unsurprisingly, Senators used the question period to ask why the Fed got its inflation call so wrong. Powell's response, as reported by CNN:

“..... we believed based on our analysis and discussions with people in industry that the supply side issues would be alleviated more quickly than now appears to be the case,” Powell said. “Substantially more quickly.”

The Fed chief added that officials expected a “much more significant return to the workforce than has turned out to be the case. ....While that is not what is causing current inflation,” Powell said, “labor supply can be an issue going forward for inflation, probably more than the supply side issues.”

Powell said supply side challenges have been “more persistent and more substantial” than expected.

Looking ahead, Powell said his expectation is there will be “some relief” on the supply front this year and global supply chains “will loosen up.” If that doesn’t happen and inflation proves to be “even more persistent and higher,” Powell said that would increase the risk of it “becoming entrenched in the psychology” of businesses and households. “That would indicate that we would respond,” he added. 

In terms of policy in the coming months, Powell was forthright concerning the Fed's willingness to act. As regards the taper of quantitative easing, he described the Fed's $ 9 trillion balance sheet as "far above where it needs to be" and said that the process of shrinking would be "sooner and faster. That much is clear". This is consistent with the last two post-FOMC statements. 

In terms of rate hikes, Powell's stance was unmistakably hawkish. Quoting again from the CNN version:

“If we have to raise interest rates more over time, we will .....We will use our tools to get inflation back.”

“To get the kind of very strong labor market we want with high participation, it is going to take a long expansion. We can see participation is only moving very slowly. And to get a long expansion, we will need price stability.”

“In a way, high inflation is a severe threat to the achievement of maximum employment and to achieving a long expansion that could give us that.”

Market expectations for what this means in practical terms have been steadily hardening, with Jamie Dimon at Goldman Sachs apparently convinced that there will be as much as 200 bp of tightening by the end of the year. With so much uncertainty over the impact of the omicron variant, that still seems improbable, but one thing that is certain is the Fed's intentions will face an early test. December CPI data are due tomorrow (January 12), and are widely expected to show a further sharp uptick in core CPI to well above 5 percent, the highest reading in decades. You sure you want another four years in the job, Jay?

This won't continue (or, Smoothie King vs. Scotiabank)

North American employment data for December were released today and provided contrasting surprises on both sides of the border.  The US non-farm payrolls report was weaker than expected, while the equivalent Canadian data were way above expectations. The coming months will no doubt bring more surprises, but it seems safe to say that the exact pattern seen in December will not be repeated. 

In the United States, the Labor Department reported that the economy added 199,000 jobs in December, the lowest total for any month of 2021. That was only about half of the number expected by the market, though that consensus may have been biased upward by the outsize 800,000 gain seen in the ADP employment report just a few days ago. However, it's also worth noting that the number of jobs added in November was revised higher by more than 100,000, so today's news is not all bad. The unemployment rate slipped to 3.9 percent, just two ticks above its pre-pandemic level, but total employment in the US remains 3.6 million below its February 2020 level. 

In Canada, the economy added 55,000 jobs in December, twice what the market was expecting. That headline number in some ways understates the strength in the jobs market in the month: there were 68,000 part-time jobs lost in the month, but that was swamped by a gain of 123,000 full-time positions.  The unemployment rate was unchanged at 5.9 percent, still just above its pre-pandemic level of 5.7 percent.

There is one key measure by which the recovery in Canada's job market has far surpassed that in the United States. As noted above, total US employment is still well below its pre-pandemic level. In contrast, while part time employment in Canada is still close to its February 2020 level, full-time employment is 248,000 (or 1.6 percent) higher, thanks to steady gains in recent months. 

Why can we predict that the pattern seen in December unlikely to be repeated?  The answer is the omicron COVID variant. Both December employment surveys were taken before the full impact of omicron was understood, so the data may present a false picture, but the differing outlooks largely reflect the divergent policy responses on each side of the border.

We can illustrate this by looking at the National Basketball Association. Last evening I watched the New Orleans Pelicans playing against the Golden State Warriors at the Smoothie King Centre in NoLa. The seats were packed and the crowd was raucous. By contrast the last home game for the Toronto Raptors, a win over the San Antonio Spurs on Tuesday, was played before an empty house at Scotiabank Arena in Toronto. 

Canada has gone into full panic mode over omicron, with gathering places such as arenas facing strict capacity limits, restaurants and gyms closed and so on. In contrast, the US seems determined to try to ride out micron as much as possible, a decision that has also been taken by the UK government. It remains to be seen who's right here, but there can be little doubt that the divergent approaches will lead to very different employment outcome in January and beyond.

Movie madness

I ended last year with a brief comment on a recently-watched movie (The Power of the Dog), so let's start 2022 in the same vein. Plenty of time for more serious stuff later.

We watched Don't look up, the hard-to-categorize disaster movie-cum-satire on Netflix. Reviews have ranged all the way from "masterpiece" to "worst movie ever made". For us it was somewhere in between, not least because the first hour is so much better than the second.

It's presumably not a spoiler by now to say that the premise is that a team of astrophysicists discover a comet heading directly for Earth, and try with mixed success to warn the world of the approaching danger. For the first hour, at least, it is very evidently played for laughs, though a surprising number of online reviewers don't seem to have clued in to that. The satire is not of a quality to cause Armando Iannucci any sleepless nights, but it's serviceable enough. Politicians, journalists and even the scientists themselves are the target of some reasonably well-aimed barbs.

The second half of the movie flags badly, with much less focus on the satire as the comet looms ever closer. The A-list cast (Leonardo di Caprio, Jennifer Lawrence, Meryl Streep, Mark Rylance) are watchable throughout, but the whole thing becomes tedious well before (spoiler redacted). 

Supposedly we are to read the whole thing as a cri de coeur from the movie makers that we take a looming existential crisis (climate change) seriously before it's too late. If that's the case, I'm not sure it really works: the message I took from it is that experts can make their best efforts, but politicians and rich people will always find a way to screw things up. That's largely true, but the movie offers no ideas at all about how that dilemma can be solved.

At the other end of the quality spectrum, we re-watched Stanley Kubrick's astounding Barry Lyndon. This may be the most visually perfect movie ever made. I paused it once or twice at random points for comfort breaks -- it runs over three hours --  and coming back into the room and seeing the still image on the screen was like entering an art gallery. The music is excellent too and reflects Kubrick's unflagging attention to detail.

Much of the criticism of Barry Lyndon tends to focus on Ryan O'Neal's performance in the title role. His Irish accent is certainly hit-or-miss. However, the criticism of his overall acting ability (or lack thereof), while justified, may be beside the point. In a Kubrick movie, nothing is left to chance, so we should assume that this is what Kubrick wanted, a tabula rasa performance that almost makes Barry a bit player in his own story rather than the focus of it.   

We're not done yet!  After enjoying Barry Lyndon, my wife and I have agreed that next week's three-hour marathon will be Visconti's 1963 masterpiece The Leopard (Il Gattopardo), starring Burt Lancaster and Claudia Cardinale.  Life's too short, and the pandemic's too long, for bad wine and bad movies. Happy New Year!