That damned, elusive recession

They seek it here, they seek it there, the media seek recession everywhere. On Tuesday Statistics Canada reported that Canada's real GDP rose 0.7 percent (or 2.9 percent annualized) in the third quarter of the year, almost twice the expected pace. So what did the media report? well, the headline on this story from the CBC website is fairly typical: "Canada's economy is still growing but signs of slowdown are everywhere".  

The media have been saying more or less the same thing since at least May and they have been mostly wrong. Are they right this time? Well, maybe. The StatsCan report shows that the biggest source of growth in the quarter was the export sector, which posted a 2.1 percent real terms gain, led by crude oil, bitumen (i.e. tar sands products) and agricultural/fisheries products. Several indicators of the domestic economy paint a noticeably softer picture: inventory accumulation provided a strong boost to overall growth for the second consecutive quarter, which is likely unsustainable, while housing investment fell for a second straight quarter, obviously in response to Bank of Canada rate hikes

Perhaps most significant of all,  household spending edged down by 0.3 percent in the quarter, its first decline since Q2/2021. This may in part reflect slowing growth in employee compensation, which rose at the slowest pace since Q2/2020,  the worst point of the COVID pandemic. In addition, the household savings rate rose in the quarter to 5.7 percent, which is more than twice as high as was seen in the same quarter of 2019 (i.e. before the pandemic). This suggests the belt-tightening the Bank of Canada wants to see is beginning to occur, though household savings are still much too low to protect the majority of households against the effects of the Bank's policies.  

As usual, StatsCan also reported the latest monthly GDP data alongside the quarterly figures. Real GDP edged up by 0.1 percent in September, led by the goods-producing sectors (other than manufacturing). Preliminary data suggest that GDP was unchanged in October, though these preliminary estimates have been subject to considerable revision in the recent past. We can perhaps reasonably assume that real GDP will be little changed for Q4.  Let's suppose GDP then starts to fall -- though that is, of course far from certain.. Given that the media's favoured definition of a recession is two straight quarters of declining GDP, that would mean it would not be possible to call a recession until the Q2/2023 GDP data appear -- at the end of next August! By that time the media's initial recession call will be well over a year old. Nice job, guys and girls. 

In case you missed it...

For some reason the turnaround in the Canadian Federal Government's finances continues to be ignored by the media. This is, of course, allowing the Conservatives, particularly their noisy new leader Pierre Poilievre, free rein to spout endless untruths about the dire state of the national fisc.  Poilievre is probably right to say that the COVID measures were initially overdone and then removed too slowly, but that does not alter the fact that the situation has now changed dramatically. 

The Department of Finance reported this past week that the Federal budget recorded a deficit of C$ 2,2 billion in September 2022, down from a shortfall of C$ 11.4 billion in the same month last year. For the 2022/23 fiscal year to date (i.e. April-September), the budget has seen a surplus of C$ 1.7 billion, compared to a deficit of C$ 68.6 billion in the same period of fiscal 2021/22.  Revenues are up across the board, while spending is sharply lower as a result of the expiry of COVID-related programs. One small blot on the overall picture is the rise in public debt charges, as Bank of Canada tightening translated into higher financing costs as maturing debt is rolled over. 

The Government's Fall Economic Statement at the start of November projected a deficit for the full fiscal year of C$ 36.4 billion -- and here we are, halfway into the fiscal year, with the budget still in cumulative surplus. There are at least three reasons to expect the budgetary position to worsen in the next few months: the regular seasonal pattern in Federal budgets always sees worse results in the second half of the fiscal year; the new spending measures announced in the Fall Statement will start to kick in; and the much-anticipated recession may finally materialize. Still, it already seems likely that the final outcome will be a significantly lower deficit than the Finance Minister projected less than a month ago.

Canada CPI: not bad, but not good

With gasoline prices heading back up again, the consensus expectation for Canada's October CPI foresaw a slightly higher year-on-year rate. As it turned out, Statistics Canada reported this morning that headline CPI rose 6.9 percent from a year earlier, the same pace as in September. Month-on-month the rise in CPI was 0.7 percent, up from only 0.1 percent in September, but this was almost entirely due to a big jump in gasoline prices. It still seems likely that the peak of the inflation spike has passed, but improvement in the year-on-year rate is likely to be slow.

Gasoline and food prices continue to be the principal drivers of headline CPI, both statistically and in the eyes of the public. Gas prices jumped 9.2 percent in October, pushing the year-on-year change, which had been falling in recent months, back up to 17.8 percent. However, there are some signs of moderation in food prices, which rose only 0.4 percent on a seasonally adjusted monthly basis in October, down from 1.2 percent in September; this still leaves food prices 10.1 percent higher than a year ago.

Stripping out food and energy prices, core CPI edged down to a 5.3 percent gain in October from 5.4 percent in September. Two of the Bank of Canada's three preferred inflation measures ticked higher in the month. The mean value of these measures remains just above 5 percent.  Average hourly wages, which the Bank of Canada is undoubtedly watching nervously, rose 5.6 percent in the year to October, up from 5.2 percent in September. 

What happens next? Gasoline prices have been much better behaved in November than they were last month, so it seems likely that the strong month-on-month gain in headline CPI seen in October will not be repeated this month.  However, even if monthly gains return to a slower track, it will still take some time for the closely-followed year-on-year number to fall significantly, since the outsized monthly gains seen last winter are still biasing the calculation higher. The Bank of Canada is approaching the end of the current tightening cycle, but a further 50 basis point increase in the target rate is likely in December. 

Pete's brag sheet

Many years ago I worked in a Bay Street dealing room with Peter Bethlenfalvy, who is now Ontario's Finance Minister. Once or twice a years, he and I and the rest of our colleagues used to compile what we called a "brag sheet": a list of all the ways we'd made money for the firm, designed to maximize our share of the bonus pool.  

I have no need for a brag sheet any more, but Peter B. still seems to have the appetite for it. His Fall Fiscal Statement, release on Monday, is a veritable paean to all the things the Doug Ford government is doing to advance the Provincial economy. The headline of the press release is typical brag sheet stuff: "Ontario Delivers Progress Report and Advances its Plan to Build". Many of the "targeted measures" listed in the release are previously announced items, such as some ill-advised roadbuilding schemes, while others have the status of "proposals".  

There is also a highly braggadocious "building Ontario progress report" that lists a wide variety of mostly off-budget items for which the Province seeks to take credit. These include commitments by automakers to invest in battery development in Ontario, a "critical minerals strategy" to attract investment, and the hiring of 11,700 health care workers. Media interviews with Peter B. after the update was tabled strongly suggest  that he -- and, no doubt, Premier Ford -- resent the fact that they get little recognition for this last item. 

The only significant sort-of-new measure that most Ontarians will notice is an extension of the Government's gasoline tax rebate; set to expire at the end of this year, it will now remain in place through 2023. Premier Ford evidently thought this was such a red hot idea that he stole Peter B.'s thunder, pitching up at his local gas station in Etobicoke on Sunday morning to make the announcement. 

Something Peter B. can't brag about too much is the bottom line. It is likely that nobody was more amazed than Peter when the Province recorded a C$ 2 billion surplus for fiscal 2021/22, which ended in early April, compared to a C$ 20 billion-plus deficit originally expected.  No surplus this year: the update projects a deficit for FY 2022/23 of C$ 12.9 billion, though it should be noted that this is well below the C$ 19 billion projected back in the Spring budget. 

Like the recent Federal fiscal update, the Ontario update offers differing courses for the deficit beyond this year.  However, in both the slower and faster growth scenarios, the deficit is forecast to be on a steady downward path, with a return to surplus in FY 2024/25 or at latest 2025/26. The Province's own fiscal watchdog, in its most recent update, was even more optimistic about the timing and sustainability of a return to balance. 

Unless things go drastically wrong -- and recent history suggests they usually do -- the budget should at worst be close to balance by the time of the next Provincial election.  Given Ontario's dubious distinction as the most indebted non-sovereign jurisdiction in the world, this would represent something of an accomplishment. 

That darn Phillips curve again

Bank of Canada Governor Tiff Macklem delivered a speech in Toronto today that attempts to set out the Bank's  rationale for tightening policy even as fears of recession mount. There's nothing particularly new, but the speech does make a few things more explicit than they have been up till now.  Unfortunately, that turns out not to be particularly reassuring.

When the economy is operating above maximum sustainable employment, businesses can’t find enough workers to keep up with demand. As a result, prices go up and inflation rises. That’s where we are today.

No, it isn't. The Governor seems to be saying that current inflation is the result of excessively tight labour markets forcing up wages and thereby compelling companies to raise prices -- in other words, a wage-price spiral. That's not what's happening at all. Inflation is largely the result of pandemic-related supply shocks, exacerbated by the impact of the Russian invasion of Ukraine.  Wage gains have been creeping up but remain well below the rate of inflation, rather than pushing it higher.

One thing that Macklem's statement does make clear is that the Bank is fully onboard with the so-called Phillips curve, which nowadays is generally taken to imply there is a direct tradeoff between tight labour markets and inflation. There's one problem with this, even if we are not bothered by the fact that Phillips's paper was written more than sixty years ago. That paper showed a statistical relationship between the unemployment rate and wages, not inflation. It might be reasonable to assume that high wage gains can be curbed by tightening policy and boosting unemployment, but when you have inflation that is almost entirely unrelated to wage gains -- today's situation -- it becomes much harder to see the logic of trying to curb inflation that way. 

Demand is what the Bank influences with interest rate increases. Our analysis suggests that because the labour market is hot and we have a high number of vacant jobs, we can afford to cool the economy without causing the surge in unemployment that we experienced in previous recessions.

Wait, what?  The whole logic of the Bank's recent policy moves surely relies on the Phillips-y idea that cooling the economy from its current condition of excess demand will bring down inflation, in large measure by cooling wage demands. But Macklem seems to be saying that this can be achieved without significantly boosting the unemployment rate. It's not remotely clear how that's supposed to happen. 

Is there anything in the speech that helps us understand what the Bank's next moves might be? Well, there's this: That’s why we have front-loaded our interest rate increases.

At the risk of over-parsing, the use of the past tense "have front loaded" rather than "are front-loading" might be the merest of hints that the Bank is finished with outsized rate hikes and will proceed more cautiously from now on. Given the apparent flimsiness of the Bank's underlying assumptions, however, it's hard to be certain about that. 

Canada's Fall Economic Statement

Canada's Federal Finance Minister (and putative PM in waiting) Chrystia Freeland has spoken regularly about her commitment to fiscal responsibility. The Fall Economic Statement, released on Thursday, offered her a chance to put those words into practice. In the event, though far from irresponsible, it did not quite measure up. 

The Federal Government has been expressing concern over the rising risk of a recession in 2023, and of course the media are (wrongly) convinced a recession has already begun. Rather than keeping its fiscal powder dry to deal with that recession if, as and when it happens, the Government has chosen to introduce a raft of new spending measures right away -- and these are not one-off measures. You can find a list here. The measures are targeted and individually modest in size, but nevertheless add up to new spending amounting to C$ 30 billion over the next five years. Tory Leader Pierre Poilievre is unimpressed and it is reasonable to assume that the Bank of Canada, which is trying hard to slow the economy down, is not best pleased either.

Rather than focusing on the individual spending measures, it is more useful to look at how the Government's economic and fiscal projections have evolved since the budget was tabled back in the Spring. This annex to the official release has all the data one could possibly want, and it leads to some surprising conclusions. 

At budget time, the deficit for the 2022/23 fiscal year (roughly April-March) was forecast at C$ 52 billion. Data for the first five months of the fiscal year, released last week, showed the actual outcome was in fact a small surplus. In the absence of any new policy measures, Thursday's document states that the deficit for the full year would now be projected at C$ 23 billion, but -- and it's a big but -- the actual projection is C$36.4 billion! In addition to C$ 6.1 billion announced yesterday (part of that C$ 30 billion over five years referred to above), the statement casually slips in the fact that policy actions  announced since the budget (but before this week) amount to a further C$ 7.3 billion.  In effect, the Government intends to spend C$ 13 billion more than it announced just six months ago; to put it another way, it intends to spend almost half of the windfall represented by the difference between the initially projected deficit and the updated version. It is hard to see this as restraint.  

An interesting twist in this statement is the publication of a detailed "downside scenario" for the economy and the budget, designed to show what might happen if the slowdown in the economy in 2023 is worse than suggested.  For FY 2022/23 -- which, recall, is already half over -- the projected deficit balloons from the baseline C$ 36.4 billion to a startling C$ 49.1 billion.  With so little of the fiscal year left and the economy conspicuously not yet in recession (see: October employment data), this seems highly unlikely, especially as the Government is continuing to benefit hugely from high energy prices, which show no sign of going away any time soon.  

The deficit projections in the downside scenario remain above the base case throughout the customary five-year planning cycle, although they do fall gradually from a 2023/24 peak in excess of C$ 50 billion. Meantime in the base case, the deficit peaks in the current fiscal year and fall steadily thereafter, leading to -- wait for it -- a surplus of C$ 4.5 billion in FY 2027-28. This is the first time that the Trudeau Government, elected in 2015 on a promise to run small deficits for just a few years, has actually projected a surplus. It would be unwise to take it to the bank. 

The jobs keep coming

Employment data for October were released in both Canada and the United States this morning. Despite some uncertainty in the details, the new numbers give little cause for hope that monetary policy tightening will soon be at an end. 

In Canada, employment had been flat to slightly lower each month since May. That pattern of stagnation ended abruptly in October, with Statistics Canada reporting that the economy added 108,000 jobs in the month, versus the reliably risible analysts' expectation of just 10,000. A rise in the participation rate meant that the unemployment rate held steady at 5.2 percent, modestly above the record low 4.9 percent posted in June and July. 

Details of the report were uniformly strong. All of the new jobs created in the month were full-time; the new jobs were spread across the country, with six Provinces posting higher employment and the rest little changed; construction, manufacturing and accommodation were among the sectors posting gains, with retail trade the only significant laggard; and the private sector posted a solid gain of almost 75,000 jobs in the month after several months of small job losses. Year-on-year, both private and public sector employment are up by about 3 percent. 

One aspect of the report that will be of concern to policymakers is the rise in wages. Hourly wages accelerated to a 5.6 percent gain in October from 5.2 percent in September.  Given the widely-reported tightness in the jobs market, this is hardly surprising, and the gain remains more than a full percentage point below headline CPI.  However, even if we are far from the dreaded "wage-price spiral", the Bank of Canada will be watching the trend in wages with some trepidation. 

As for the United States, today's report from the BLS shows that non-farm payrolls rose 261,000 in October -- above market expectations for a rise of 200,000 but lower than the 315,000 jobs added in September. The unemployment rate edged up two ticks to 3.7 percent. So far this year, the average monthly gain in employment has been 404,000, so there is at least some sign that the jobs market may be starting to react to the Fed's policy actions, but from any longer-term perspective the monthly numbers are still strong and the market is indisputably tight. 

On the wage front, the news in the US is perhaps a little more encouraging for policymakers. Average hourly earnings rose 4.7 percent in the year to October, compared to 5.0 percent in September -- both figures are, needless to say, far below the increase in CPI.  It is beyond dispute that wages have almost nothing to do with the inflationary pressures in the US, so the Phillips-curve-based policy approach of combatting inflation by raising interest rates seems unlikely to be effective. That may not be enough to deter the Fed from remaining on its recent course. 

Another 75 from the Fed

It's getting to the point where these blog posts about FOMC decisions can be done on a cut-and-paste basis. As expected, the Federal Reserve today imposed its third fourth straight 75 basis point increase in the funds target range, which now stands at 3.0 - 3.25 3.75-4.0 percent. The press release signals there are more rate hikes to come, and also commits the Fed to continuing its policy of quantitative tightening. 

As was the case after the last two rate hikes, the press release's discussion of the economic background to its decision is skimpy. although Chair Jerome Powell's opening statement at his post-FOMC press conference was considerably more expansive and detailed.  Apart from a short paragraph on the impact of Russia's depredations in Ukraine, this is the press release's entire text on the economy:

Recent indicators point to modest growth in spending and production. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures.

Once again, the release offers little indication that the Fed yet sees any signs that its tightening policies are having the desired effect on either the real economy or inflation. Nor is there any mention of inflation expectations, even though keeping these in check is surely the main goal of this series of sharp rate hikes, since there is not much monetary policy can realistically do about the underlying causes of the recent inflation spike. 

The press release states that the FOMC anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time. It goes on to add the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. That sentence, together with the customary statement that the Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee's goals, has initially been interpreted by financial markets as a hint, however faint, at the possibility of a "pivot". 

It is something of a surprise that the Fed is not making any attempt to convince markets that its policy approach is working. Headline CPI is still way above target on a year-on-year basis, but by definition half of the data points that make up that number are more than half-a-year old. The latest monthly prints have been much lower than those seen at the start of the year. While that owes much to the fall in gasoline prices, it does appear that the peak in inflation has passed, even if the year-on-year rate will only reflect that fact as the next few months unfold.  

Are there more "supersized" rate increases to come?  Asked about this at the press conference, Powell did not rule it out, although he suggested that the question of moving to a more moderate pace of tightening would likely be on the agenda at the next FOMC meeting. The funds rate is now closing in in the most recent (i.e. September) 'dot plot" percent projection of a 4.6 percent rate in 2023.  It seems likely that the pace of tightening will slow soon, but there is every indication that FOMC believes that it will take a prolonged period of high rates to get inflation back to the target.