Slowly slowing, maybe

A couple of last-minute data points for the Bank of Canada's Governing Council to consider, ahead of its scheduled rate announcement tomorrow (June 1). Statistics Canada reported this morning that real GDP rose 0.7 percent month-on-month in March, marginally below the 0.9 percent recorded in February. For the first quarter as a whole, real GDP grew 0.8 percent (or about 3.1 percent at an annualized rate), slower than in the two preceding quarters and below market expectations. 

Both the March and the Q1 figures point to a reasonably resilient domestic economy, particularly when you recall that COVID restrictions remained in place across much of Canada during the quarter.  StatsCan describes the March increase as "broad-based": fourteen of the twenty sub-sectors it tracks posted gains in the month, with both goods and services sectors growing. As for the Q1 data, the most noteworthy takeaway is that final domestic demand rose 1.2 percent in the quarter, up from 0.9 percent in the final quarter of 2021.  The slowdown in overall growth was the result of a decline in export volumes attributable, somewhat surprisingly, to the energy sector. 

One potential source of concern can be found in StatsCan's preliminary estimate of GDP growth for April. This estimate suggests that real GDP grew by only 0.2 percent in the month, with broad-based slowing in both goods and services output.  This is not altogether surprising in light of the strong monthly growth recorded in both February and March. Before jumping on the recession/stagflation bandwagon, it might be worth keeping in mind that 0.2 percent monthly annualizes to about 2.5 percent, which is higher than the Bank of Canada's estimate of the economy's sustainable growth rate. 

All in all, today's data suggest that the Bank of Canada's primary focus must for now remain on inflation, rather than any risk of a downturn in the economy. Although monetary policy is all but helpless in dealing with supply-side shocks, the Bank has to act in order to keep inflation expectations in check. This points to a 50 basis point increase in the rate target tomorrow -- which markets have already priced in -- with at least one more such increase coming later in Q3.  

There may be trouble ahead

In the wake of tentative moves toward monetary tightening by the Fed and the Bank of Canada, and with interest rates still way below either historical norms or neutral levels, growing fears of recession or stagflation seem exaggerated.  Still, it's worth looking at the ongoing data flow to see if there are any signs that the doomsters may turn out to be right. Today's release of new retail sales data from Statistics Canada is a good place to start, especially as it offers lessons in the importance of not reading too much into the headline number. 

That headline number certainly looks weak: according to StatsCan, "retail sales were virtually unchanged" in March -- and note, by the way, that this is already a dated report, this being the last week of May. The figure released today is certainly below StatsCan's preliminary estimate, which had called for a rise of more than 1 percent. However, as soon as you move on to the second sentence of the press release, things start to look rather less clear: "Sales were up in ten of eleven subsectors"!

That's right. All of the weakness in the headline figure came down to a 6.4 percent decline in sales at motor vehicles and parts dealers. The remaining ten subsectors, which account for 75 percent of overall retail sales, all posted gains in the month, led by a 7.4 percent increase in gasoline sales. Using StatsCan's definition, which excludes gasoline and vehicle dealers, core retail sales actually rose 1.5 percent in the month. 

There is, naturally, a further complication. All the numbers quoted so far are in nominal terms. Given the well-publicized surge in inflation, we would expect real (i.e. inflation-adjusted) retail sales to present a different picture. That is indeed the case: retail sales in volume terms fell 1 percent in the month* . For the first quarter as a whole, the volume of retail sales rose only 0.2 percent, even as the nominal value of sales rose 3.0 percent, the fastest pace seen in more than a year. 

In keeping with its recent practice, StatsCan is offering its preliminary estimate of retail sales for April: a 0.8 percent gain in nominal terms.  The vertiginous rise in gasoline prices stalled or even slightly reversed in April, so this nominal increase may correspond to a small increase in the volume of sales for the month.  Given the importance of retail trade to the overall economy, a prolonged decline would have very serious implications. For the moment it remains too early to predict that. The situation bears close scrutiny, but releases like today's will not deter the Bank of Canada from continuing its policy tightening. 

* One area of strength: cannabis stores, up 11 percent in volume terms in the month and up more than 30 percent from a year ago!

Could have been worse, and likely soon will be

Canada's headline CPI rose 6.8 percent year-on-year in April, up from the 6.7 percent rise recorded in March, according to data published today by Statistics Canada. This is the highest rate seen in more than three decades.  The news might have been worse -- just look at the UK, where the ONS today reported a 9 percent CPI increase for April -- but there is every likelihood that CPI will continue to set new highs in the next few months. 

Food, energy and shelter costs continue to be the biggest contributors to the rise in inflation, even though gasoline prices edged lower in April after a double-digit surge in March. Food costs rose 0.9 percent month-to-month in April, led by prices for food purchased from stores, while shelter costs rose 1.1 percent. Even with the slight fall in gasoline prices, transportation costs rose 0.5 percent in the month. In all, the monthly rise in CPI was 0.6 percent, down from the gasoline-driven 1.4 percent recorded in March. This sounds encouraging until you stop to consider that 0.6 percent annualizes to a rate well above the current year-on-year figure. 

Most of the special aggregates reported by StatsCan show lower year-on-year increases than headline CPI: ex food, up 6.4 percent; ex energy, up 5.4 percent; and ex food and energy, up 4.6 percent. Once again, however, a glance at the month-on-month increases tells a less encouraging story. Each of these aggregates posted a 0.6 percent rise in April, which indicates that inflation pressures are broad-based and are showing no sign of moderating.

And then there are the Bank of Canada's preferred inflation measures. All three of these have been edging steadily higher for many months, and that trend continued in April. The average of the three measures rose by 0.3 percent to just above 4.2 percent in the month.

There is nothing in this report to dissuade the Bank of Canada from continuing its aggressive tightening actions. It is already possible to predict that the May CPI will be another horror show.  The performance of the core inflation indices shows that price pressures are broad-based,  while gasoline prices across the country have hit new all-time highs this week -- and this is the week in which StatsCan collects the data for its May CPI release.  The inflation surge is clearly top-of-mind with the Canadian public, judging by media coverage. It is hard to see inflation expectations remaining contained if the Bank of Canada does not continue to talk -- and act -- tough.  

Hold the applause

"Everybody's desperate, trying to make ends meet;

Work all day, still can't pay the price of gasoline and meat.

Alas their lives are incomplete".

(Warren Zevon, Mohamed's Radio)

The prophet Zevon wrote those words almost fifty years ago, but they have been ringing very true in recent months, as soaring costs for fuel and food have pushed US consumer price inflation to multi-decade highs. Despite a strong real economy and rising employment, a majority of Americans give the Biden administration very poor marks for its handling of the economy. That's entirely due to inflation. 

This morning the Bureau of Labor Statistics released CPI data for April. On the surface, the data seem to offer a glimmer of hope that the inflation spike may have peaked. The year-on-year rise in headline CPI slipped marginally for the first time since August 2021, falling to 8.3 percent from March's 8.5 percent. The monthly change was only 0.3 percent, down from 1.2 percent in March.

So far, so good, but some of the details are less reassuring. A major contributor to the lower print was a 6.1 percent month-to-month drop in gasoline prices, but that has already been reversed in May. Indeed, the national average gas price has hit a new high this month, likely setting the stage for a fresh bounce in  overall CPI when the May data are reported. 

The year-on-year rise in core CPI, excluding food and energy costs, slipped to 6.2 percent in April from 6.5 percent in March, but the monthly change in this measure tells a different story: it rose 0.6 percent in April, twice as fast as in March. The rise in core CPI appears to point to broadening price pressures that have little to do with the well-publicized supply chain issues -- but even those may be set to become more severe again, given the return to COVID lockdowns in China. 

Purely for statistical reasons, there is a good chance that year-on-year headline CPI will decline very modestly in the next few months, as outsize monthly gains from 2021 fall out of the index. However, the rate of progress back towards the Federal Reserve's 2 percent target is likely to be agonizingly slow. Significant further tightening of monetary policy is all but certain for the remainder of this year.  

The jobs keep coming, for now

The abysmal performance of financial markets in recent weeks has the media in full-on panic mode. Sample headlines today: "A recession may be around the corner" (CNN); "More warnings that stagflation is coming to North America" (CBC). That negative print for US Q1 GDP didn't help, with very few commentators taking the time to notice that the decline was mainly the result of an inventory adjustment rather than any weakness in final demand.

In any case, if the US and Canadian economies are about to slide into recession, nobody has told the jobs market. Both countries added jobs in April, with the Canadian report also showing the lowest unemployment rate on record, at 5.2 percent. There may be trouble ahead, but for now the real concern is that the central banks started tightening way too late, not that they will have to reverse course sometime soon. 

Starting with the US, data released this morning by the Bureau of Labor Statistics show that the US economy added 428,000 jobs in April, leaving the national unemployment rate unchanged at 3.6 percent. The gains were broad-based, with leisure and hospitality, manufacturing and transportation leading the way; no sector tracked by the BLS showed significantly lower employment in the month. Even with these latest gains, total non-farm employment remains about 1.2 million below its pre-pandemic peak. While employment tends to be a lagging indicator of economic activity, it seems clear that the Q1 GDP decline was a statistical anomaly rather than the first step towards recession.  

As for Canada, the jobs gain of 15,000 was weaker than analysts had expected, but this pause came after gains totalling more than 400,000 in the preceding two months (and almost a full million in the past year).  The weakness in the overall number is largely explained by a loss of 27,000 jobs in Quebec, which has been worse affected by the latest wave of the pandemic than most other Provinces. All of the employment gains in the month represented part-time positions, but Statistics Canada continues to identify signs of a tightening labour market, including a falling rate of involuntary part-time employment and a falling rate of labour force underutilization. 

In both countries, wage gains remain well below the running rate of inflation. In the US, hourly wages are 5.5 percent higher than a year ago, while in Canada the corresponding figure is 3.3 percent. It is hard to have a wage/price spiral as long as wages remain under control. Still, the central banks are even by their own admission behind the curve here; for now, there is nothing in the employment data to deter then from pursuing the tightening course they have clearly set out. 

Fed walks the walk

Given the steady stream of hawkish rhetoric from the Federal Reserve over the past several weeks, it can have surprised no-one that today's FOMC meeting ended with a double-barrelled shot of tightening. The Fed raised the funds target range by 50 basis points, bringing it to 0.75-1.0 percent, and also detailed its plans to shrink its balance sheet by reducing its holdings of Treasuries and other securities. 

Even before today's announcement, the sharp selloff in both equity and fixed income markets had led to warnings that the Fed would not be able to bring inflation back to its 2 percent target without tipping the US economy into recession. The recent report that US GDP slipped in Q1 seemed to give extra urgency to such warnings, but the press release correctly notes that "household spending and business fixed investment remained strong. Job gains have been robust in recent months, and the unemployment rate has declined substantially". 

Some of these warnings of recession almost seemed to imply that the FOMC was flying blind, unaware that its tightening was all but certain to lead to selloff in major markets. This is, of course, ridiculous, and today's press release seems carefully designed to reassure markets that the Fed knows what it is doing.  As a result, the tone is perhaps a little more dovish than some market participants had feared.  The release makes it clear that the Fed expects to continue tightening in the months ahead, but also stresses that it will be ready to change course if circumstances require it to do so. 

The key word in the release is "appropriate", and the FOMC uses it twice:

"With appropriate firming in the stance of monetary policy, the Committee expects inflation to return to its 2 percent objective and the labor market to remain strong".

and

"In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook". 

It can reasonably be assumed that the FOMC's view of an appropriate stance for monetary policy is one in which interest rates are neutral, that is, neither directly expansionary nor contractionary for the economy. That rate is still probably 150-200 basis points higher than the newly-set  funds target, and it is of course possible that the Fed would have to move rates above neutral for a time if inflation proved particularly sticky. As things stand, therefore, there are several more rate hikes to come, but markets can be reassured that the Fed is not on auto-pilot, and can change course if necessary.