Canada GDP still motoring along

OK class, please pay attention, because the GDP data released by Statistics Canada this morning are a bit complicated. Real GDP is now estimated to have grown 0.1 percent in March, up from an earlier estimate of zero growth;  the preliminary April estimate of 0.2 percent growth has now been revised down to zero; and the preliminary estimate for May shows a sharp acceleration to 0.4 percent. 

The reason for the gyrations mainly comes down to the lengthy public sector strike that took place in April. That strike led to a 0.3 percent decline in public sector output, the largest such contraction since April 2020. The end of the strike naturally led to a bounce-back in public sector output in May, boosting that month's overall GDP estimate. The best way to look at the two months of data is probably to average the two figures, which yields a 0.2 percent growth rate for both April and May, or an annualized growth rate of about 2.5 percent.  That may not be robust, but it certainly cannot be called a recession, despite what you may read in both mainstream and social media.  

Looking briefly at the sectoral breakdown, it appears that 11 of the 20 sub-sectors tracked by StatsCan posted higher output in April, with the goods-producing sector overall posting 0.1 percent growth. Mining and quarrying posted a fourth straight month of strong growth and construction activity advanced, while manufacturing output fell 0.6 percent, its first decline in four months. The preliminary data for May suggest a rebound in manufacturing and, as already noted, public sector output, partially offset by lower mining and quarrying output. 

We now have on hand most of the data that the Bank of Canada will be weighing up when it makes its next interest rate decision on July 12.  In terms of inflation, the May data were encouraging at the headline level -- up 3.4 percent from a year ago -- but the Bank was expecting this and no doubt still believes it will be hard to get inflation all the way down to the 2 percent target. Today's growth figures are more or less in line with most estimates of the economy's potential growth rate, but that does little to allay the Bank's oft-stated concerns about the lack of slack in the economy.

The one important data series that will be updated before rate decision day is the labour force survey: data for June will be published on July 7.  With the unemployment rate already near historic lows and wage gains finally outpacing inflation, it is likely to take a very weak report to convince the Bank that its policy  tightening can be paused again.  Markets are only pricing in about a 50 percent chance of another rate hike, but looking objectively at theh data, the likelihood seems higher than that. 

Canada May CPI: getting there

Canada's consumer price index came in slightly lower than expected in May, according to data released this morning by Statistics Canada. Headline CPI rose 3.4 percent from a year earlier, a full percentage point lower than the April reading and the lowest yearly increase since June 2021.

As has been the case for several months now, much of the change in the yearly rate reflects the so-called base effect, as outsized monthly gains from the first half of 2022 fall out of the calculation. In May the base effect was most notable for gasoline, where the price last month was 18 percent lower than in May 2022. If gasoline is excluded, the yearly rise in CPI fell to 4.4 percent in May from 4.9 percent a month earlier.

Other closely watched components of the overall price index continue to rise uncomfortably quickly. For the third straight month, the largest single contributor to the monthly increase came from mortgage interest costs, up 29.9 percent from a year ago. It hardly needs be pointed out that this is the direct result of the Bank of Canada's interest rate hikes. Food prices are also rising much faster than headline inflation, up 9 percent from a year ago, only marginally slower than in April. 

There are some positive elements in the release from the Bank of Canada's perspective. Seasonally adjusted headline CPI, which surged 0.6 percent month-on-month in April, rose only 0.1 percent in May, though both monthly figures were distorted by the gyration in gasoline prices. The Bank's three preferred measures of core inflation all decelerated noticeably in May, with the mean reading falling to 4.3 percent from April's 4.7 percent. 

It is unlikely that today's numbers will deter the Bank from raising rates by a further 25 basis points in July, though a weak real GDP print for May (data due this coming Friday) could just possibly tilt the balance. It seems unlikely that the Bank ended its "conditional" pause at its last meeting with the intention of only making one tightening move. Moreover, it should be recalled that although today's numbers are encouraging, they are exactly in line with the Bank's expectations: Governor Tiff Macklem and others have repeatedly forecast that headline CPI would fall close to 3 percent by mid-year, exactly what we now see happening. 

The Bank's concern is that getting inflation all the way back to the 2 percent target is likely to be more challenging, not least because the benign impact of the base effect is almost over. Expect another 25 basis point rate hike in July, very possibly accompanied by another "conditional" pause to give the Bank more time to judge the impact of its policy actions. 

As expected: unch'd.

In line with almost unanimous market expectations, the Federal Reserve kept its funds target range unchanged at 5.0-5.25 percent today, ending a ten-meeting-long sequence of rate hikes.  The tone of the press release can perhaps be best described as neutral, giving no real clues as to whether this is the end of the current tightening cycle or simply a pause. 

The Fed is careful to stress. more than once. its continuing commitment to restoring inflation to the 2 percent target: The Committee remains highly attentive to inflation risks, and later The Committee is strongly committed to returning inflation to its 2 percent objective.

At the same time, there are clear indications that the Fed is now confident that it has the luxury of waiting to see the full impact of the policy actions it has taken since early 2022: It offers several reasons for this:

Tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation. The extent of these effects remains uncertain.......

Holding the target range steady at this meeting allows the Committee to assess additional information and its implications for monetary policy...... 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.

Inevitably, the release closes by noting 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. That sentence, and much of the rest of the relatively short press release, is not new, but it somehow reads differently in the context of today's rate decision.

So what happens next?   Projections released alongside today's decision show that all but two FOMC members still see rates moving higher in the current cycle. Even so, it seems unlikely that the FOMC would have opted to keep rates unchanged today if it seriously felt that another rate hike would become necessary very soon, so the base assumption should probably be that this marks the start of a fairly lengthy pause.  

By the time of the next FOMC announcement on July 26, the Fed will have another month of data on both CPI and PPI;  both of these showed encouraging trends in the latest monthly data and both should benefit from a helpful base effect for at least one more month. There will also be another month of labor force data to consider. As always, the decision in July will depend on the data flow, but for now it seems reasonable to predict that if there is to be another rate hike, it won't happen until after Labor Day. 

The cause for a pause?

US CPI data for May, released by the BLS this morning, appear to set the stage for the Fed to pause any further tightening in policy when the FOMC announces its rate decision tomorrow (Wednesday).  On a seasonally adjusted basis, headline CPI rose a less-than-expected 0.1 percent in the month, compared to 0.4 percent in April. That lowered the year-on-year increase from 4.9 percent in the previous month to 4.0 percent in May, the lowest figure since March 2021. 

The FOMC will be well aware of the impact of the base effect on this latest result. While the 0.1 percent month-on-month increase is encouraging in itself, the sharp deceleration in the more closely followed yearly data mainly resulted from another of last year's outsized monthly gains falling out of the calculation. The fact that year-on-year CPI peaked in June 2022, at 9.1 percent, means that the base effect will only exert a downward influence for one more month. Consequently getting headline CPI the rest of the way down to the 2 percent target will be rather more challenging.

The FOMC will also take note of the slower progress in reducing core inflation.  CPI less food and energy rose 0.4 percent in May, identical to the increases posted in the two preceding months. That left the year-on-year increase at 5.3 percent.  While this is still way too high for the Fed's comfort, the market's firm expectation that the FOMC will leave rates unchanged, at least for this one meeting, is likely to prove accurate. 

OK, so, colour me surprised

I think I would like to take a mulligan on the final paragraph of my most recent blog entry.  Commenting on Wednesday's Bank of Canada rate rise, what I said in effect was that the Bank wouldn't have crossed up the market that way unless it had advance knowledge that the May jobs and wages data would be strong. 

Well, this morning Statistics Canada released said data and they were....not strong. Employment actually fell by 17,000 in May, as against a consensus expectation for an increase of about 20,000. This can be compared to average monthly gains of 33,000 jobs in the previous three months and close to 80,000 around the turn of the year. The unemployment rate, which had been eerily stable at 5.0 percent for the last five months, ticked up to 5.2 percent, the first increase since August 2022. As for wages, growth in average hourly earnings edged down to 5.1 percent year-on-year, 0.7 percentage points above the latest annual increase in CPI.  

All in all the data seem to suggest that the Bank of Canada's rate actions are starting to bite in the labour market, sufficiently at least to allow it to delay another month before ending its "conditional" pause. So why did it hike rates this week?  One or two technical elements in today's release may indicate that the data are overstating any weakness in employment. Most notably, a sharp fall in youth unemployment more than fully accounted for the jobs lost in the month, but StatsCan's data release carefully explains that this was the result of a large seasonal adjustment factor for the month: without that adjustment, youth employment actually rose in the month.

Then there is the historic volatility of Canadian employment data. Some commentators have already pointed to that as a reason to be skeptical about today's figures, although it may be noted that the same people had few qualms about taking the numbers at face value when they were growing strongly. 

Perhaps we need to look no further than the Bank's own statements. On June 6, just a day before the rate hike, it posted this on Twitter: "When we set interest rates, it's based on where we expect inflation will be in the future, not where it is today".  I thought then that this curiously-timed message might be intended to set the market up for a rate hike, but evidently didn't take it seriously enough to share my concerns.

Year-on-year CPI is likely to ease well below 4 percent in the next month or two, thanks to the base effect. Year-on-year wage gains are already above CPI, and any fall in CPI in the near term would soon widen that differential to more than one percentage point.  Does the Bank see that possibility as evidence that the dreaded wage-price spiral is taking shape? When it comes to explaining this week's rate hike, that seems as good a rationale as any. 

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The hawks win out

Going into today's Bank of Canada interest rate announcement, a few analysts were predicting an immediate rate hike, but the consensus was for a kind of "hawkish hold" -- tough talk and the threat of rate hikes to come, but no actual move. In the event, the Bank boosted its overnight rate target by 25 basis points, bringing it to 4.75 percent, the highest since 2001. It also provided a lengthy explanation for its decision, leaving little doubt that there may be one or more further rate hikes to come.

The press release starts by placing Canada's inflation in its international context. It appears that the Bank believes that in the US and Europe as well as in Canada, the easy part of getting inflation back to target has now been achieved, but what remains to be done is set to be trickier:

Globally, consumer price inflation is coming down, largely reflecting lower energy prices compared to a year ago, but underlying inflation remains stubbornly high. While economic growth around the world is softening in the face of higher interest rates, major central banks are signalling that interest rates may have to rise further to restore price stability.

As for Canada, the Bank notes recent evidence that the economy is continuing to operate at a higher level than previously expected, despite the aggressive rate hikes seen over the past year.

Canada’s economy was stronger than expected in the first quarter of 2023, with GDP growth of 3.1%..... spending on interest-sensitive goods increased and, more recently, housing market activity has picked up. The labour market remains tight: higher immigration and participation rates are expanding the supply of workers but new workers have been quickly hired, reflecting continued strong demand for labour. Overall, excess demand in the economy looks to be more persistent than anticipated.

In terms of inflation, the Bank is still expecting a significant decline in the very near term, but it worries about further progress after that:

CPI inflation ticked up in April to 4.4%, the first increase in 10 months, with prices for a broad range of goods and services coming in higher than expected......The Bank continues to expect CPI inflation to ease to around 3% in the summer, as lower energy prices feed through and last year’s large price gains fall out of the yearly data. However, with three-month measures of core inflation running in the 3½-4% range for several months and excess demand persisting, concerns have increased that CPI inflation could get stuck materially above the 2% target.

What the Bank is in effect saying is that most of the welcome decline in inflation over the past year has been the result of the base effect, as outsized gains from early 2022 fall out of the year-on-year index, rather than a slowing in the running rate of inflation. Recent month-on-month data have been above the levels needed to get CPI back to the 2 percent target.  This evidently justifies today's move in the Bank's opinion, and seems very likely to lead to at least one further 25 basis point move in the second half of the year -- if not at the mid-July fixed announcement date then certainly not long after. 

It is still very much open to dispute whether the Bank's aggressive rate hikes have been the right remedy for the recent bout of inflation, which was triggered by supply chain issues that are unlikely to be affected by higher interest rates. Indeed, the immediate impact of this latest rate hike will be to push the shelter cost component of CPI, already a major contributor to the overall inflation rate, even higher.

The Bank is certainly well aware of this. It seems very possible that its decision to move rates today rather than delaying in line with the market consensus is based on a sneak peek at the May employment report, due to be released on Friday. It would be no surprise to see another outsized gain in employment, very possibly accompanied by a jump in wage gains.  In fact, if that is not the case, it is unlikely that the Bank would have chosen to buck the market consensus, something it never really likes to do. 

Not surprising any more

In truth, the only surprising thing about the US employment data released this morning is that people are still affecting to be surprised when the numbers are strong. We'll get to the actual data in a second, but maybe the most interesting statistic of the day is this: according to Bloomberg, today's number marks the fourteenth consecutive month that job creation in the US has come in above the market consensus.  How does that saying go again? Fool me once, shame on you -- fool me fourteen times, shame on me. 

The BLS data reveal that non-farm payrolls rose 339,000 in May, and there were notable upward revisions to the data for the two preceding months.  So far in 2023, the average monthly rise in payrolls has been about 310,000. That's down from an average of almost 400,000 per month in 2022, but well above the sub-200,000 monthly pace of job gains seen pre-pandemic.

Somewhat surprisingly, the unemployment rate ticked up to 3.7 percent in May from 3.4 percent in April. This number is calculated from the "household survey", as opposed to the "establishment survey" that produces the payrolls number. The household survey showed a rise of 444,000 in the number of unemployed persons in May. This discrepancy is unusually large and is hard to explain, given that the labor force participation rate was almost unchanged in the month. Since the establishment survey is seen as more reliable than the household survey, it will no doubt be the headline number that is most quoted.  

The job creation numbers might suggest that the Federal Reserve cannot yet risk pausing its rate hike cycle, but the wage data tell a different story.  Average hourly earnings rose 0.3 percent in May, bringing the year-on-year increase to 4.3 percent. The Fed is likely to mark the fact that private sector hourly earnings rose 0.5 percent in the month, but there is still no real evidence of the wage-price spiral that rate hikes are supposed to forestall. Recent Fed-speak has seemed to hint that there will be at least a temporary pause in rate hikes, and for now that seems the likeliest outcome for the FOMC meeting on June 13-14.