"Navigating by the stars under cloudy skies"

Who would have thought that Fed Chair Jerome Powell had so much poetry in him? Yet the title of this post is taken from the concluding paragraph of his speech today at the annual Jackson Hole economic policy shindig.  The rest of the speech is more prosaic, but offers some useful insights into how the Fed views its progress against inflation over the past eighteen months or so and what remains to be done. TL:DR version: recent developments are encouraging, but the job is not finished and rates will stay high for some considerable time.  Some highlights: 

The Fed mainly focuses on the personal consumption expenditure deflator to monitor inflation trends; this is a holdover from the Greenspan era. However, it remains committed to bringing the more familiar CPI down to the 2 percent target: "Two percent is and will remain our inflation target".  Given that the target is in fact up for renegotiation in 2025, and given musings in some quarters (hi there, Paul Krugman) that a slightly higher target might have some merit, this is a very strong statement of intent from Powell. 

Within the PCE measure, the Fed looks more closely at core PCE (i.e. excluding food and energy), and it breaks core PCE into three sub-components, for goods, housing services and non-housing services. 

• Core goods inflation has fallen sharply, which Powell attributed to unwinding of supply chain issues, along with tighter monetary conditions. Although core goods prices fell in the last two months, this measure remains well above its pre-COVID level. 
• Costs for housing services responded quickly to Fed tightening but it will still take some time for the full effects to be felt, because not all leases expire at the same time. The Fed expects this measure to settle near its pre-pandemic level. 
• Core non-housing services, accounting for more than half of core PCE,  may be the Fed's most intractable problem.  These prices were less subject to international supply issues during the pandemic but are generally labour-intensive, which presents a problem when the job market is so tight. 

Looking ahead, while continued unwinding of pandemic-related issues will be helpful, the Fed believes a period of below-trend economic growth will be needed to get inflation back to the target. Real interest rates have moved sharply higher over the past year, but the Fed is still "attentive to signs that the economy may not be cooling as expected", so that "additional evidence of persistently above-trend growth....could warrant further tightening of monetary policy".

The Fed is surprisingly relaxed about the state of the labour market. It sees rebalancing in that market as a contributor to easing pressure on nominal wages. Still, "Evidence that the tightness in the labor market is no longer easing could also call for a monetary policy response".

Powell ended his remarks by reminding his audience of the high level of uncertainty faced by policy makers, particularly as regards the lags with which monetary policy measures take effect. The Fed sees its current policy stance as restrictive, but -- paraphrasing here -- is it restrictive enough?  Having posed that question, Powell offered up his brief moment of poesy, before finishing with a blunt declaration: "We will keep at it until the job is done". 

We didn't start the fires

......but we can certainly manipulate the story for political advantage. Everybody's doing it!

Predictably, climate change activists are blaming the extremely active fire season in the Northern Hemisphere (Alberta!  BC!! Quebec!!! Yellowknife!!!! Hawaii!!!!! Tenerife!!!!!!) on climate change. Serious scientists are careful not to say climate change is the direct cause of these extreme weather events, but journalists are not so scrupulous. I actually heard one talking head this past weekend lumping the Ventura county earthquake in with Hurricane Hillary as a symptom of climate change.

On the other side of the spectrum, climate change deniers are taking equally extreme positions. A favourite argument is that the exceptionally high number of wildfires this year is mainly down to arson.  Every year there are fires that are directly caused by humans, either campers being careless with the matches or actual arsonists.  The added spice this year is that it is now apparently necessary to blame someone specific, and the bigger the culprit, the better the story.  Here in Canada I have seen it asserted, without a shred of evidence, that "climate vigilantes" have been setting fires on the direct orders of Justin Trudeau and/or the World Economic Forum. 

Let's just think about the logistics of this tsunami of arson for a second. The reason many of the fires in northern Quebec were allowed to just burn themselves out is that they happened in areas so remote that firefighters could not gain access to them. Yet we are apparently supposed to believe that arsonists were able to move freely about in these inaccessible regions, setting fire after fire and making it home safely to tell the tale. I don't think so. 

We may be able to exonerate Justin Trudeau from any direct involvement in setting the fires, but that doesn't mean he is not heavily involved in all this. His heart-on-sleeve "green" government is naturally playing up the role of climate change in all this (and completely downplaying any impact from arson).  But Trudeau is also seizing the opportunity to advance another part of his agenda: his battle to shake down Meta and Google to force them to bail out Canada's struggling legacy media, through an Act of Parliament known as Bill C-18.

Bill C-18 requires companies like Google and Meta to pay for any links they provide to Canadian news media. Meta has responded more robustly than Google, complying with the letter of the law -- though not its intent -- by removing such links from its websites.  The Government is furious, even though anyone with half a brain (and even some experts) tried hard to warn them this would happen.

Trudeau has glommed onto the opportunity provided by the forest fires, most notably those burning around Yellowknife, to lambast Meta for putting Canadians' lives at risk by depriving them of access to fast-breaking news.  Two points here: first, my own very informal and unscientific survey suggests that virtually no-one actually relied on Meta platforms for access to news sources.  Second, Trudeau has  apparently not found it necessary to suggest to the media that they might remove their own paywalls for the duration of the crisis. So even if you still had access to, say, the Toronto Star via Facebook, you still wouldn't be able to read anything beyond the headline: the paywall would keep the actual content from you. Well thought through there, Justin. 

Canada July CPI: the sky is falling!

Spoiler alert: no, it isn't.  The headline number in the data released by Statistics Canada today is certainly surprising, but a peek into the details of the data suggests that the underlying downward trend in consumer inflation remains intact. 

The headline number, and the only one the media can be bothered to look at, was assuredly way worse than expected. Year-on-year headline CPI rose 3.3 percent in July, up from 2.8 percent in June. On a month-to-month basis headline CPI rose 0.6 percent (unadjusted), compared to a consensus expectation of 0.3 percent.

There are a lot of moving parts behind that number -- so many, in fact, that the StatsCan press release manages to be quite confusing. For example, within the first few paragraphs we read first that Acceleration in headline consumer inflation was mainly attributable to a base-year effect in gasoline prices and then that The mortgage interest cost index (+30.6%) posted another record year-over-year gain and remained the largest contributor to headline inflation.  Both statements are factually accurate, but they could undoubtedly have been better expressed or at least less closely juxtaposed. 

As the first of those two quotes may suggest, the famous "base effect" continues to bedevil the statistics. For the past year your blogger and others have been cautioning that the steady decline in headline year-on-year CPI owed a lot to big monthly inflation numbers from early 2022 falling out of the index. That process is at an end, making further progress toward the Bank of Canada's 2 percent target more difficult. Specific to the July data, StatsCan is pointing out that in July 2022 gasoline prices fell 9.2 percent, whereas in June this year they edged up 0.9 percent. That creates a very powerful base effect that biases the whole index higher.

As for the mortgage cost index, all that can really be said (again) is that Bank of Canada rate hikes are a major contributor to the above-target headline CPI.  Excluding mortgage costs, the year-on-year rise in CPI for July was 2.4 percent, within hailing distance of the Bank's target.  One interesting aside: "CPI excluding mortgage costs" is not one of the regular raft of "special aggregates" that StatsCan tabulates each month, which suggests that nobody at the agency ever expected the current situation to arise.

Speaking of special aggregates, the Bank of Canada's three favoured measures of core inflation continue to head in the right direction. The mean level of those measures edged down by 0.1 percentage points in the month and now stands at almost exactly 4 percent. 

What does this mean for the Bank of Canada's next rate decision in early September? The Financial Post headlined its report on today's data this way: "Hotter-than-expected inflation turns up heat on Bank of Canada".  But does it really?  If the Bank were to hike rates on the basis of today's headline number, it would in effect be reacting to the fact that gasoline prices fell sharply in July 2022, because that's what caused the jump in headline CPI we witnessed today. That doesn't seem very likely. 

US CPI for July: nothing much to see here

Data released by the BLS this morning show that US headline CPI rose 3.2 percent year-on-year in July, up from a 3.0 percent increase in June. This marked the first time the headline index has ticked up since this time last year, but the data do not represent any change in the underlying downward trend in inflation. Rather, the number serves to underline the fact that the so-called base effect is now played out. The outsized monthly CPI increases seen in late 2021 and early 2022 are now fully out of the yearly index, which now more accurately reflects the current inflation picture.

On a month-to-month basis, headline CPI rose 0.2 percent in July, the same pace as in June. The sub-index for shelter costs accounted for fully 90 percent of the monthly increase; that sub-index is, of course, heavily influenced by the Fed's rate hikes. Core CPI, excluding food and energy, rose 4.7 percent in July from a year earlier,  still well above the Fed's 2 percent target.  However, the monthly increase in this measure was 0.2 percent, the same as in June. The annualized rate of growth in both headline and core CPI thus seems to be running only slightly above the target rate.

All in all, today's data should give the Fed room to keep rate on hold at the September FOMC meeting, and it is quite conceivable that the current tightening cycle has reached its peak. Talk of rate cuts is certainly premature, but it is likely that year-on-year CPI will consistently have a 2-"handle" by the end of this year. 

UPDATE, August 11: Producer price index (PPI) data released today by the BLS are slightly less encouraging than the CPI data. PPI rose a higher-than-expected 0.3 percent in July, the biggest monthly gain since the start of 2023. Still, the year-on-year increase is well below the rise in CPI -- and the Fed's inflation target -- at 0.8 percent.  The most concerning aspect of the report for Fed policymakers is likely to be the fact that prices for services rose 0.5 percent in the month, as opposed to a rise of only 0.1 percent in goods prices. It is difficult to blame higher service prices on international supply shocks. 

Slowly slowing

Employment data for July for the US and Canada, released this morning in DC and Ottawa, appear to confirm a modest easing in previously tight job markets in both countries.  This is certainly what the Fed and Bank of Canada have been hoping for, though it remains far from clear that its is their policies that have actually brought it about.

In the US, BLS data show that employment rose by 187,000 in July, with downward revisions in previous estimates for both May and June.  Today's print was slightly below market expectations of 200,000 new jobs and well below the average gain of 312,000 recorded over the past twelve months. It was also marginally below the average monthly employment gains recorded in pre-pandemic days, although the relevance of that comparison is steadily diminishing. 

The gain in employment left the unemployment rate virtually unchanged at 3.5 percent, within the narrow range that has been in place for the past year. Average hourly earnings rose 0.4 percent in the month, for a year-on-year gain of 4.4 percent. This suggests that wages are now more or less keeping up with inflation, but offers scant evidence that the historically tight jobs market has produced anything like a wage-price spiral -- real wages are well below their pre-inflation-spike level. 

In Canada employment fell by a statistically insignificant 6,400 jobs in the month, with almost all of the losses coming in part-time employment. The sempiternally useless analysts' consensus had expected a gain of 25,000 jobs. The lack of new jobs was sufficient to push the unemployment rate up for a third straight month; it now stands at 5.5 percent, still low by historical standards. 

Until recently it had been remarkable that employment seemed to be keeping up with the rapid growth in the labour force that has resulted from unprecedented immigration levels. This no longer appears to be true: from January to July, the population has grown 1.4 percent, while employment has only risen 0.7 percent. This will bear close watching in the months ahead, as there is no reason to think that immigration levels will slow any time soon. 

In contrast to the US, wage gains may yet be an issue in Canada, at least in the Bank of Canada's eyes. Average hourly wages, which had slipped to a 4.2 percent year-on-year increase in June, bounced back to a 6.0 percent increase in July. The past few months have seen a marked increase in strike activity across Canada -- Federal public servants in May, BC port workers in July, Toronto supermarket staff currently -- as unions seek to recoup purchasing power lost over the last two years. The Bank will be watching this closely, though none of the wage settlements that have been announced so far seem to be directly inflationary.

All in all, today's data appear to give both the Fed and the Bank of Canada room to pause their tightening cycles in the near term. That said, there is still plenty of data to come before they reconvene to decide their next rate moves toward the end of the summer.

Finally, just one local anecdotal note. Yes, I know economists aren't supposed to use anecdotal evidence but -- spoiler alert -- all economists do. One of our successful local hostelries has just announced that it is significantly reducing its opening hours until further notice, because it simply cannot find the staff to open normally. The unemployment rate in my area is generally above the national average, so one can only imagine that similar things are taking place elsewhere in Canada. I'm just sayin'.