Not dead yet* (Canadian edition)

Ahead of this morning's release of GDP data for August, the Canadian media were quite ready to declare that the economy was already in deep doo-doo and that things could only get worse from here. Consider this article from the CBC website, loudly proclaiming that "the bad economic times have only just started".  Regular readers of this blog (or of the Canadian media) will know that this headline could have appeared any time over the past eighteen months, without ever actually being accurate.  Are things finally different this time?

StatsCan's data shows that real GDP was unchanged in July, after a 0.2 percent decline in June.  Weakness in goods producing sectors, particularly manufacturing, was offset by gains in service-producing sectors.  The monthly data continue to be noisy, making it tricky to determine the underlying trend. Most notably, sectors affected by wildfires in June -- mining, oil and gas, accommodation and food services -- rebounded in July.  Of the twenty sectors monitored by StatsCan, nine posted higher output in July.

So, with real GDP falling in June (and for Q2 as a whole) and not increasing in July, the stage is set for a relatively weak Q3.  StatsCan's preliminary estimate shows that GDP likely edged up by 0.1 percent in August, with further gains in service sectors offset by weakness in retail trade and oil and gas extraction. The sensible interpretation of today's numbers seems to be that the economy is muddling along rather than collapsing, with good months and less good months alternating. 

This has been the case since early this year and it looks likely to continue for some time yet, as the impact of Bank of Canada rate hikes continues to feed through the economy.  Whether this eventually produces the "official definition of a recession" that the media love so dearly -- two consecutive quarters of declining GDP -- remains to be seen.  But in any case, real GDP is arguably not the indicator the media and policy makers should be focused on right now.

Next Friday (October 6) we can expect to see employment data for September. Recall that in August, the economy added a robust 40,000 new jobs -- but the unemployment rate rose as high immigration added more than 100,000 people to the workforce.  The temperature of the debate over immigration has thankfully dropped slightly in recent weeks -- media have other things to think about, courtesy of Justin Trudeau's blunder-of- the-week club -- but the numbers coming into the country have not.  Even if the economy stays out of recession in the coming months, it is hard to see how it can possibly create enough jobs to absorb all those looking for work.  A steady rise in the unemployment rate would soon have politicians clamouring for rate cuts, something the Bank of Canada will be reluctant to provide unless inflation resumes its downward course. 

* I used this Monty Python quote as the title of a blog post way back in 2012, when I was still living in the UK. The post was about the media crying doom over the economy despite the absence of any hard evidence. There's a surprise. 

Five Eyes and Nazis

This has not been a good couple of weeks for the Justin Trudeau government....

Trudeau's visit to the G20 summit in New Delhi in mid-September seemed unusually tense. He spent very little time with his host, India PM Narendra Modi, skipped one of the formal functions and then got stranded in India for two days because his geriatric official aircraft needed emergency repairs. 

Soon after Trudeau's return to Canada, the reason for the coldness of his welcome in India became clear. Trudeau rose in the House of Commons to announce that Canada had intelligence connecting the government of India to the assassination in British Columbia of a prominent Sikh activist who favoured establishment of a separate Sikh state, "Khalistan". Unsurprisingly India did not react well, denying the allegation outright and launching a series of tit-for-tat measures that shows no signs of ending any time soon. 

Here's the thing: it now looks as though the intelligence on which Trudeau is relying was not provided by the Canadian security agency CSIS.  Rather, it came from an unidentified member of the "Five Eyes" intelligence sharing alliance. (In my long-ago diplomatic service days, Five Eyes was usually referred to in documents as "AUSCANZUKUS", which I expect the reader can figure out quickly enough).  Since it was the US ambassador to Canada that revealed this fact, the best guess is that the US actually originated the intelligence.

Whether or not that is the case, the near-silence of the other Five Eyes countries in supporting Trudeau here is remarkable, and highly chastening for a leader whose first public statement to the international community on being elected in 2015 was "Canada's back".  Back it may be; as important as India, it evidently is not. Nobody looks good here.  India is under a cloud of suspicion; CSIS has apparently been shown to be unable to monitor suspicious activities of foreign nationals within Canada's borders; Trudeau has gone out on a limb using intelligence that he probably cannot independently verify and has so far declined to make public; and the Five Eyes "allies" are letting Trudeau and Canada twist in the wind out of fear of offending Modi. 

While all this was unfolding, Canada received a visit from the peripatetic Ukrainian leader Volodymyr Zelensky, who followed up a speech at the UN General Assembly with meetings in Ottawa and Toronto.  In Ottawa, Zelensky addressed Parliament, and an array of prominent Ukrainian-Canadians were invited to attend.  One of these was a 98-year old WW2 veteran, Yaroslav Hunka, who received a personal ovation from the politicians and the rest of the assembled crowd as it was announced that he had fought against the Russians during the war. It does not seem to have occurred to anyone, but it came out soon enough, that those Ukrainians who fought the Russians back then were fighting alongside the Nazis -- and indeed, Hunka was not just a common-or-garden Nazi, but a full-fledged member of the Waffen SS. 

Cue outrage from all sides: the opposition parties in Parliament, of course, the Jewish community, and even the Kremlin, which surely took delight in this confirmation of its contention that the purpose of its "special military operation" in Ukraine was to de-Nazify the country. The search for a fall guy ramped up fast, with House of Commons Speaker Anthony Rota appearing to take full responsibility for the gaffe. Hurta lives in the riding represented by Rota, so that may indeed has been the source of the initial invitation.  But Hurta was granted a face-to-face meeting with Zelensky and Trudeau; given the level of security that surrounds both men, it is hard to believe that nobody looked into Hurta's past before approving his presence -- unless this is yet more evidence of the incompetence of CSIS.

And meanwhile on the domestic front, housing crises, mounting concern over immigration levels and anger over rising food prices continue to poison public opinion.  Any impression that Trudeau is in control of events vanished long ago; even he may soon realize that the only way to reset the agenda here is to call an election -- and if he prayed to be defeated, you could hardly blame him. 

Fed rate announcement: no change

 As expected, the two-day FOMC meeting ended with the Fed keeping the funds target unchanged at 5.25-5.50 percent.  The press release continues to talk of "solid" economic activity, "strong" job gains and "elevated" inflation. Overall, the wording is very little changed from the July FOMC, and seems to suggest that the tightening cycle is either at an end or at least very near to it. 

This extract from the longest paragraph of the release summarizes the Fed's by now well-established view on the outlook:

The Committee will continue to assess additional information and its implications for monetary policy. In determining the extent of additional policy firming that may be appropriate to return inflation to 2 percent over time, 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,

Today's meeting also produced an update of the periodic chart deck that allows us a more detailed insight into the FOMC's thinking. The Fed now expects real GDP growth to average very close to 2 percent in each of the next three years, in line with the economy's estimated growth potential. If this is achieved, it will be the textbook example of a soft landing. The PCE deflators, both headline and core, are expected to have a "2 handle" (i.e. to be "2 point something") starting in 2024 and to return to the actual 2 percent target by 2026. 

Then there is the famous "dot plot" that shows the expectations of FOMC members for the level of the funds target,  For now, a small majority of the Committee appears to expect one further rate hike before the end of 2023. However, only one member is looking for rates to move still higher in 2024, with most expecting rates to fall at least slightly during that year and to continue to decline after that.  In line with recent Fed rhetoric, there is nothing to support the idea that rate cuts will either come early or be very aggressive when they do come. 

The overall impression we can take from this is that while the Fed may not be ready to call "job done", it is very confident that it is on the right track and sees no need for a significant change of course.  If the economy really is set to grow at a rate in line with potential over the next three years, there is no obvious need to contemplate rate cuts until it is completely clear that inflation is heading back to the 2 percent target. Things can change quickly, as a prospective government shutdown, a possibly lengthy auto makers strike and uncertainty over the strength in oil prices make all too clear.  For now, however, it seems that any changes in Fed policy over the next six to twelve months will be in the nature of tweaks rather than sudden shifts. 

Canada CPI higher in August -- but not for food

Last week, Prime Minister Justin Trudeau summoned the heads of Canada's major grocery chains to a special meeting in Ottawa, threatening them with unspecified measures if they did not come up with a plan to curb rising prices. That meeting duly took place on Monday, although Trudeau was otherwise engaged and his deputy, Finance Minister Chrystia Freeland, could only be bothered to attend the meeting for two minutes. 

Given that grocery price inflation has been visibly slowing in recent months, why is the Government suddenly leaning on the retailers? We may have got an answer to that this morning. As part of the release of CPI data for August, Statistics Canada reported that grocery prices actually fell 0.4 percent month-on-month.  That dropped the year-on-year gain, which topped 11 percent earlier this year, to 6.8 percent, the lowest reading since January 2022.  Is it too, too cynical to assume that the government, with some kind of a heads-up from StatsCan about the data, leapt into action so as to be able to claim credit for something that was already well under way?  Perish the thought. 

The rest of the report, particularly the headline number, is less reassuring, though as usual there are special factors at play.  The headline number rose sharply to 4.0 percent in August from 3.3 percent in July, the second straight increase.  As was the case in July, the result was heavily influenced by base effects in the price of gasoline, which rose 4.6 percent in the month. This pushed the year-on-year change to a 0.8 percent increase in August from a 12.9 percent decline in July.  There is not much the Bank of Canada can do about that. 

On the other hand, shelter costs are definitely within the Bank of Canada's purview, and are continuing to add to overall inflation levels. Specifically, the mortgage interest cost index accelerated further in August to 30.9 percent year-on-year. StatsCan also observes that a higher interest rate environment, which may create barriers to homeownership, put upward pressure on the (rent) index.  Rents rose 6.5 percent year-on-year in August, up from 5.5 percent in July. 

The various special indices calculated by StatsCan serve to confirm the Bank of Canada's fears that getting inflation all the way back to the 2 percent target will be challenging. CPI ex food rose 3.5 percent year-on-year, while the index excluding food and energy rose 3.6 percent.  Moreover, two of the Bank's three preferred measures of core inflation, which had been edging lower for most of the year, moved slightly higher in August. 

There will be one more monthly CPI reading before the Bank of Canada's next rate setting, scheduled for October 25. For the moment, markets are seeing a 50/50 chance of another rate hike at that time.  Given that higher rates are contributing significantly to inflation (mainly via the shelter index), a further rate hike seems almost perverse. However, the Bank of Canada will have to weigh that against its own credibility and the credibility of the whole inflation targeting framework. 

The Hunter hunted

I don't normally comment on US politics here, unless it's relevant to something I'm writing about the US economy.  As a non-American I am cautious talking about a system of governance I still find hard to fathom, even though living just five miles from the border gives me a ringside seat. 

However, I just want to put down a few thoughts about the situation surrounding Hunter Biden.  It's striking to see the lengths to which CNN, in particular, is going in an effort to play down this feckless dolt's multitudinous transgressions and to minimize the possibility of any of this incriminating President Biden, even while admitting that there is plenty that just doesn't smell right.

The Biden camp admits that Joe Biden, while serving as Vice-President to Barack Obama, took part in phone calls with various actual or prospective business associates of Hunter. Yet supposedly, no business was ever discussed in these calls.  This stretches credibility an awfully long way, but let's assume for a second it's true. All that was discussed in these calls was the weather and the latest NFL odds.  

If that was indeed the case, what was the purpose of the calls?  It can only be an attempt by Hunter to use his father's exalted position to boost his own business prospects.  That's called influence peddling, and it worked: Hunter was paid a fat stipend to lend his name to a Ukrainian oil company, even though he likely could never have found Ukraine on a map and wouldn't know crude oil from Oil of Olay. 

If this was all indeed "only" influence peddling, what does that say about Joe Biden?  Shouldn't a man of his experience and in his exalted position have realized that this was a very ill-advised, indeed dumb thing to do?  It shouldn't take the wisdom of Solomon for Joe Biden to know that if any of this came out, it would make him look corrupt or at least stupid, neither of which is a good look for the most powerful man in the world.

Coming back to CNN for just a second, their take on the Republicans making so much of Hunter's problems and threatening to impeach President Biden is that it's just a ploy to divert attention from Donald Trump's mounting array of legal issues.  But you could equally look at it the other way round: it's only Trump's innumerable transgressions that make it possible for the Democrats to try to sweep the Biden family's issues under the rug. 

Running hard but still falling behind

So, first the good news. According to Statistics Canada, the Canadian economy added 39,900 new jobs in August. That was about twice as large as the reliably risible analysts' consensus.  Fully 32,200 of the new jobs created in the month were full time. As a result of the large increase in employment, the unemployment rate was unchanged at 5.5 percent, after edging higher in each of the previous three months.

If only that were the whole story.  Thanks to rapidly rising immigration, the working age population rose by fully 103,000 in the month.  This meant that despite the strong job numbers, the employment rate, which measures the number of persons over age 15 actually working, fell by 0.1 percentage points, to stand at 61.9 percent. Note that the employment rate is not the same as the more frequently quoted participation rate, which includes the unemployed as well as the employed in the calculation. That ratio also slipped by 0.1 percentage points in the month, to stand at 65.5 percent. 

This is not just a one-month phenomenon. The working age population has grown by an average of 81,000 per month so far in 2023. Making allowance for normal dependency and participation patterns, the economy would need to create an average of 50,000 jobs per month to keep the unemployment rate unchanged.  The actual average monthly increase in employment so far this year has been 25,000. Note that these numbers come directly from the StatsCan media release -- they are not calculations done by me or some other analyst. 

This hardly seems like a sustainable pattern. There is evidence of serious pressure on housing markets across the country, with the three levels of government -- Federal, Provincial and municipal -- all pointing the finger of blame at each other. Canada has always had sickeningly high numbers of "rough sleepers" on city streets, but that sad phenomenon seems likely to be worse than ever just as the cooler weather starts to arrive.  Yet there are few signs within the Federal government, which ultimately controls overall immigration levels, that anything will be done to address the problem.

What does all this mean for Bank of Canada policy? A strong rise in employment is hardly a recipe for stable interest rates, let alone rate cuts. And yet, the massive rise in the working age population makes it possible to argue, as at least one major bank economist has already done today, that the tightness in the labour market may actually be easing despite the job gains.  This is a difficult argument to sustain unless you have evidence that the qualifications of the new arrivals match those needed in the labour force.  

Only time will tell if that is the case, though it should be added that large segments of the Canadian economy, from agriculture to medicine,  would collapse overnight but for the presence of immigrants. Muddling through without any sort of plan may work out just fine in the end, but the imbalance between population growth and employment in today's numbers suggests things could very quickly turn sour. 

On hold, but not happy about it

Mainly in response to last week's report of a decline in GDP during the second quarter of the year, markets had scaled back almost to zero their expectations for a further rate hike at today's Bank of Canada Governing Council meeting.  The Bank did indeed keep its overnight rate target unchanged at 5 percent, but the assertive tone of most of the press release gives the strong impression that but for that GDP report, today would have brought another rate hike. Consider these quotes: 

"....with measures of core inflation still elevated, major central banks remain focused on restoring price stability".

"Recent CPI data indicate that inflationary pressures remain broad-based..... CPI inflation is expected to be higher in the near term before easing again. Year-over-year and three-month measures of core inflation are now both running at about 3.5%, indicating there has been little recent downward momentum in underlying inflation. The longer high inflation persists, the greater the risk that elevated inflation becomes entrenched, making it more difficult to restore price stability"

Neither of those statements sounds like a central bank that thinks its work is done, but the latest developments in the real economy clearly made it impossible for the Bank to justify another rate hike at this time:

"The Canadian economy has entered a period of weaker growth, which is needed to relieve price pressures..... Economic growth slowed sharply in the second quarter of 2023, with output contracting by 0.2% at an annualized rate.......Final domestic demand grew by 1% in the second quarter, supported by government spending and a boost to business investment. The tightness in the labour market has continued to ease gradually. However, wage growth has remained around 4% to 5%".

Is there perhaps a hint of a suggestion there that the Bank wishes the Federal Government was not making its job harder by continuing to boost public spending?  Sure sounds like it, though the Bank is always careful not to make political statements, at least in public. Politicians, alas, feel no such constraint: the Premiers of both British Columbia and Ontario penned very public letters to Governor Tiff Macklem in recent days, urging the Bank not to hike rates further. And in the wake of the Bank's announcement, Federal Finance Minister Chrystia Freeland has issued a statement welcoming the news. These are not welcome developments and it's to be hoped they do not set some kind of precedent. 

The final paragraph of the press release deserves to be quoted in full:

"With recent evidence that excess demand in the economy is easing, and given the lagged effects of monetary policy, Governing Council decided to hold the policy interest rate at 5% and continue to normalize the Bank’s balance sheet. However, Governing Council remains concerned about the persistence of underlying inflationary pressures, and is prepared to increase the policy interest rate further if needed. Governing Council will continue to assess the dynamics of core inflation and the outlook for CPI inflation. In particular, we will be evaluating whether the evolution of excess demand, inflation expectations, wage growth and corporate pricing behavior are consistent with achieving the 2% inflation target. The Bank remains resolute in its commitment to restoring price stability for Canadians". 

Not to over-analyze that, but the fact that the "evidence" in the first sentence is described as "recent" rather than as, say, "growing" seems to underscore the importance of the GDP data in the Bank's decision today. The rest of the paragraph is just about as hawkish as anything the Bank has said over the past year and more; given that the Bank's definition of price stability continues to be the 2 percent target, it is clear that further rate hikes cannot be ruled out. Before the next rate setting date of October 25, we will see two more monthly sets of both employment and CPI data, as well as GDP data for August. It will take clear signs of weakness across that data set to take another rate hike off the table. 

The long-awaited recession??

So, is this the start of the long-awaited (and for the media, seemingly much-desired) recession in Canada? Statistics Canada reported this morning that real GDP fell at a 0.2 percent annualized rate in the second quarter of the year. It takes two quarters of declining GDP to meet the "official" definition of a recession, but weak monthly GDP data for June and July suggest that a further decline in Q3 is at least a possibility.

Before we look at the details, let's just pause to think about what a "0.2 percent annualized rate" looks like. StatsCan correctly states in its media release that "real gross domestic product (GDP) was nearly unchanged in the second quarter", not that the media will take any notice of that form of words.   If we "de-annualize" the number we find that it means real GDP in Q2 was 0.05 percent smaller than in Q1. That barely even qualifies as a rounding error, and it could well be eliminated (or, equally probably, revised to a larger decline) when updated estimates are available in a few months' time. 

Looking deeper into the data, we immediately see evidence that the Bank of Canada's aggressive rate hikes are having an impact on at least one segment of the economy. Housing investment fell 2.1 percent in the quarter; this was its fifth consecutive quarterly decline, which corresponds remarkably closely to the duration of the Bank's tightening moves. StatsCan calculates that this factor alone accounted for a 0.65 percent annualized rate of decline in real GDP, so aside from the decline in housing, real GDP would have risen at about a 0.4 percent annualized rate in the quarter.

It is worth spending an extra moment looking at the implications of this weakness in housing. Immigration levels into Canada are running at an unprecedented pace, led by surging numbers of foreign students, refugees and more conventional migrants. The country's population hit 40 million earlier this year and is set to grow by at least a million this year and next -- and there are suggestions that the numbers may in fact be undercounted. Unsurprisingly, this is putting great pressure on the housing market, as well as social services in general. The news that new housing construction plunged by 8.2 percent in Q2 could not have come at a worse time. 

Returning to the StatsCan data, we find a number of other contributors to slower growth. Business inventory accumulation slowed in the quarter, a development that may well be partly attributable to Bank of Canada policy, given the rising cost of carrying unsold goods. The trade sector was also a source of weakness, at least in a statistical sense, as growth in imports outpaced a very marginal rise in export volumes.

Growth in household spending was markedly lower in the quarter, posting a rise of only 0.1 percent after a gain of 1.2 percent in Q1. Interestingly, or perhaps ominously, per capita household spending fell 0.7 percent in the quarter, a development almost certainly linked to the large rise in population.  On a more positive note, real business investment rose 2.4 percent in the quarter after a prolonged bout of weakness. All in all, final domestic demand posted a rise of 0.3 percent in the quarter (about 1.2 percent annualized), a number that is in line with the previous quarter and that does not seem consistent with an imminent recession. 

As usual, StatsCan also posted new data on monthly GDP growth. Real GDP fell 0.2 percent in June, with both goods and services output falling.  Preliminary estimates show that real GDP was little changed in July, and it is this weak "handoff" from Q2 to Q3 that suggests overall weakness in growth could persist through the current quarter. That being said, it might be worth noting that the monthly data are particularly noisy at the moment. StatsCan notes that the severe forest fire season depressed output in a number of key sectors in June, and the prolonged port strikes in BC must also have had an impact. Experience suggests that the economy usually bounces back quickly from such events, but it may take some time for the impact on the monthly data to wear off.

Today's numbers represent the last major data point to emerge before the Bank of Canada's rate setting meeting on September 6.  Markets had been pricing in about a 25 percent chance of a further 25 basis point rate hike, but that now looks unlikely to happen.  Raising rates in the wake of a negative GDP report would be more than just a bad look for the Bank -- it would be bad policy.