Enough's enough

The BLS reported this morning that the US economy added only 12,000 jobs in October, and September's report was revised lower by more than 100,000......blah blah blah. I'm guessing you're getting bored with these posts of mine, and I'm getting bored with writing them. If you're a regular visitor here, you'll have noticed that I have been posting much less frequently than in the past, which reflects the fact that I'm just not enjoying it any more.

I'm not going to take the blog down, but from now on I will only post if I think I have something important to say, which is unlikely to happen very often. 

Thanks for visiting. You will still find me from time to time on Twitter/X (mostly about economics and politics) and on Threads (mostly about music, movies and sport), so maybe I'll see you around.

Jim

Outsized jumbo

After last week's news that Canada's headline CPI fell to 1.6 percent in September, market expectations for the next Bank of Canada rate move swiftly pivoted to a 50 basis point reduction, rather than the 25 basis point cuts seen up until now.  The media characterized such a potential move as "outsized", "jumbo" and such, although those with longer memories (such as your blogger) know that such moves  were commonplace in the past. There were even a few voices calling for a 75 basis point cut.

Today the Bank of Canada duly met the consensus expectation, delivering a 50 basis point cut that brings the overnight rate target to 3.75 percent.  The longer-than-usual media release, accompanied by an updated Monetary Policy Report, is at times almost triumphalist in tone. It is clear that the Bank is now convinced that it has, along with its international peers, successfully brought the economy to the much-vaunted soft landing. 

The international picture is favourable, notwithstanding the armed conflicts in Ukraine and the Middle East (which don't even merit a mention): The Bank continues to expect the global economy to expand at a rate of about 3% over the next two years.... Inflation in advanced economies has declined in recent months, and is now around central bank targets. Global financial conditions have eased since July, in part because of market expectations of lower policy interest rates. Global oil prices are about $10 lower than assumed in the July Monetary Policy Report (MPR).

As for Canada, the Bank acknowledges that the economy remains in excess supply (as reflected in the higher unemployment rate), but expects faster growth to absorb that excess in the coming years: In Canada, the economy grew at around 2% in the first half of the year and we expect growth of 1¾% in the second half. Consumption has continued to grow but is declining on a per person basis..... GDP growth is forecast to strengthen gradually over the projection horizon, supported by lower interest rates. This forecast largely reflects the net effect of a gradual pick up in consumer spending per person and slower population growth..... Overall, the Bank forecasts GDP growth of 1.2% in 2024, 2.1% in 2025, and 2.3% in 2026. As the economy strengthens, excess supply is gradually absorbed.

The Bank's comments on the inflation outlook are worth quoting in full:

CPI inflation has declined significantly from 2.7% in June to 1.6% in September. Inflation in shelter costs remains elevated but has begun to ease. Excess supply elsewhere in the economy has reduced inflation in the prices of many goods and services. The drop in global oil prices has led to lower gasoline prices. These factors have all combined to bring inflation down. The Bank’s preferred measures of core inflation are now below 2½%. With inflationary pressures no longer broad-based, business and consumer inflation expectations have largely normalized.

The Bank expects inflation to remain close to the target over the projection horizon, with the upward and downward pressures on inflation roughly balancing out. The upward pressure from shelter and other services gradually diminishes, and the downward pressure on inflation recedes as excess supply in the economy is absorbed.

One small curiosity here. At the time of its last rate announcement, the Bank warned that a "base effect" could push CPI temporarily higher in the coming months, as low monthly increases from a year ago fell out of the calculation. No mention of that this time, even though the risk of a near-term uptick surely remains. September's decline in headline CPI below the 2 percent target, welcome as it may have been, was in the end largely down to a sharp fall in gasoline prices. Gas prices have rebounded strongly in October, so it would be no surprise to see an immediate uptick in headline CPI. Evidently the Bank is convinced that the easing in overall price pressures is now sufficiently broad-based that it need no longer fret unduly over this possibility. 

As well as announcing the 50 basis point rate cut, the Bank ends its media release with something close to a promise: If the economy evolves broadly in line with our latest forecast, we expect to reduce the policy rate further. However, the timing and pace of further reductions in the policy rate will be guided by incoming information and our assessment of its implications for the inflation outlook. We will take decisions one meeting at a time.

This may or may not turn out to be the only "outsize jumbo" rate move in the current easing cycle. However, it is now clear that the overnight rate target will head towards 3 percent in the next few months. Further reductions beyond that point will only happen if the real economy underperforms the  Bank's expectations. 

Now what (part deux)?

The strong September employment data announced in the US last Friday effectively derailed expectations of another 50 basis point Fed rate cut any time soon. So how will markets react to the Canadian employment data released this morning, which are even stronger?

Per Statistics Canada, the Canadian economy added 47,000 jobs in September, after several months of little change. The increase served to push the unemployment rate slightly lower, to 6.5 percent, ending a long run of gradual increases. Details of the report were generally robust: there were 61,000 new private sector jobs in the month, offset by some job losses in the public sector; full time employment rose by 112,000; the job gains were well-dispersed across the country, with only BC and New Brunswick reporting lower employment; and hourly earnings rose 4.6 percent from a year earlier, lower than in August but still well ahead of inflation.  

Despite all these signs of strength, there are still some lingering issues. The employment rate (i.e. the percentage of the working-age population actually in employment) continued to edge lower in September despite the strong jobs gains. This reflects Canada's very rapid immigration-driven population growth. The national population rose an estimated 110,000 in September, to stand almost 1.2 million (or 3.6 percent) higher than a year earlier. The unemployment rate only ticked lower because the labour force rose by a surprisingly small 16,000 in the month.

The strong employment data seem to give the lie to the significant number of media types and other experts who have been loudly declaring that the Canadian economy is "already in recession", which it clearly is not. There have been suggestions that the Bank of Canada might follow the Fed in implementing a 50 basis point rate cut in the near future. With the Fed now likely to follow a more cautious path for a while, today's data show there is no compelling reason for the Bank to deviate from its current policy of gradual easing. 

Now what?

September's non-farm payrolls report, released this morning by the Bureau of Labor Statistics, came in way above market expectations. What does this mean for the US economy and for the direction of Federal Reserve policy? 

Employment rose by 254,000 in September, more than 100,000 above the level markets had expected. This is comfortably higher than the average monthly gain of 203,000 posted over the past twelve months. Moreover, the relatively weak monthly increases reported for July and August were revised higher by a total of 72,000 jobs.  For the second straight month, the unemployment rate ticked down, to stand at 4.1 percent. Average hourly earnings rose 0.4 percent in the month to stand 4.0 percent higher than a year earlier, and are now reliably running ahead of the rate of inflation. 

Recent Fed-speak, including the statements made after last month's FOMC rate cut, have clearly shown that the Fed is now largely convinced that it has got inflation under control, allowing it to focus more on signs of weakening in the jobs market. To the extent that the Fed was using the July and August non-farms data as evidence of that weakening, the upward revision of the data for those months might be seen as a sign that the 50 basis point cut was an over-reaction. The strong September data certainly suggests the same thing. In that case, it would be reasonable to expect that the two remaining FOMC meetings this year will bring smaller rate cuts, or even conceivably a pause in the easing cycle as the Fed waits for more data to come in. 

There are at least two factors complicating the near-term rate outlook. First, the October jobs numbers are likely to be messy, thanks to the strike at Boeing, the strike (albeit now over) at East Coast ports and the lingering impact of Hurricane Helene.  (Note, however, that in reporting today's numbers the BLS said that Helene has had no measurable impact on the data).  These factors may all bias the October data downwards, but given the statistical "noise" in the numbers, the Fed will react cautiously. Second, the ever-expanding mayhem in the Middle East may push global oil prices sharply higher, which would affect prices in the US even though it is no longer reliant on energy supplies form that region. 

The next FOMC meeting is set to take place right after election day.  While it is quite possible (to say the least) that the outcome of the vote will not be known by the time the Fed makes its announcement, there is no risk that whatever decision is announced can be construed as "political". Barring any major surprises in the data flow, the likeliest outcome in both November and December is for a 25 basis point rate cut, but a pause in the easing cycle becomes more likely as we move into the new year. 

Doing things by halves

The US Federal Reserve today launched the widely-anticipated easing cycle with a full 50 basis point rate cut, dropping the fed funds target range to 4.75-5.0 percent. Market expectations had gravitated toward a move of this size in recent trading sessions. Interestingly, and unusually in recent times, one FOMC member, Michelle Bowman, voted in favour of a 25 basis point cut.  

The media release  is surprisingly anodyne, considering how much weight markets had been placing on today's decision. The key passage is this one: The Committee has gained greater confidence that inflation is moving sustainably toward 2 percent, and judges that the risks to achieving its employment and inflation goals are roughly in balance. The economic outlook is uncertain, and the Committee is attentive to the risks to both sides of its dual mandate.

Alongside the media release, the Fed has released updated economic projections. The widely-followed "dot plot" shows that a small plurality of FOMC members expect the funds target to fall by a further 50 basis points by year end. (Reminder: there are two more FOMC meetings scheduled for the remainder of 2024). Further easing is expected through 2025, with the funds target expected to end that year at about 3.25 percent. 

The risk for the Fed in starting the easing cycle with an outsized cut is that investors might assume the economic situation is much worse than previously thought, leading to a selloff in equity markets. Evidently the messaging from the Fed ahead of the announcement has worked, because the initial reaction on Wall Street has been a modest move higher. Markets will now focus on Chair Jerome Powell's press conference for clues about whether there are more large rate cuts on the horizon: fearless prediction, Powell will say it all depends on the data. 

Right on target!

Canada's headline CPI finally returned to the Bank of Canada's target in August, falling 2.0 percent year-on-year from the 2.5 percent posted in July, according to data released today by Statistics Canada. This was the lowest annual increase since February 2021.  

The chief contributor to the fall in the headline rate was the price of gasoline, which fell 2.6 percent in August to stand 5.1 percent lower than a year ago. However, the easing in inflationary pressures is broad based, as shown by the fact that CPI excluding the cost of gasoline slowed to 2.2 percent in August from 2.5 percent in July. The one truly sticky sub-component continues to be shelter costs, up 5.3 percent from a year ago. Amid continuing rapid population growth, there is little prospect of any relief in this area. 

The Bank of Canada's three preferred measures of core inflation all eased in August. Their mean value now stands at just over 2.2 percent and one of them, "CPI-common", now stands exactly at the Bank's 2 percent target.

In making its latest rate reduction earlier this month the Bank warned that the base effect could briefly turn unhelpful late this year, pushing headline CPI readings higher. That warning remains relevant, but there is no doubt that the Bank is now in a much better position to focus its attention on supporting the real economy and the employment market, rather than exclusively on combatting inflation. Depending on how the data look in the coming weeks, the possibility of at least one 50 basis point rate cut before year-end has clearly increased. 

And lastly, just for some light relief, I can't resist quoting the headline from the CBC website's report on today's data:  "Canada's inflation rate finally hit the Bank of Canada's target. What does that mean for prices?" Well, duh. 

US economic policy: bad ideas galore!

What with all the insults, threats and bizarre assassination attempts. one aspect of the ongoing US Presidential election campaign is going largely unnoticed.  Both candidates are wheeling out some of the most ridiculous economic policy proposals in living memory.  Here are just a few.

The biggest and potentially most damaging proposal is Donald Trump's pledge to impose tariffs on just about everything the US imports, with a view to reducing income taxes. It's clear that his Wharton degree did not equip him to understand how tariffs work.  He believes that any tariffs he introduces would be paid by foreign countries. It does not seem to occur to him that either (a) the tariffs would be passed on to US consumers, thus rapidly pushing up inflation, or (b) countries and companies would simply stop shipping their products to the US, in which case the tariffs would not produce any revenue and the shelves at WalMart and just about everywhere else would rapidly empty.

What's worse, it's impossible to imagine that foreign countries would not react to Trump's tariffs by retaliating with their own tariffs on American exports. As the experience of the 1930s showed, that's a recipe for a global recession, or worse -- and the global economy is much more closely integrated now than it was in the 1930s.

Sticking with Trump for the moment, his latest genius idea is to exempt all overtime earnings from income tax. He affects to believe that this would promote and reward hard work, but the likely consequence is surely the exact opposite.  How many tasks that workers are currently able to accomplish in a 40-hour work week would suddenly start to consume more time, compelling employers to pay overtime? How many new jobs might never be created as existing workers start to demand overtime rather than allowing the employer to add new workers?  And how would this be implemented for salaried workers, many of whom routinely work more than forty hours a week? (Asking for a friend on that last one, obviously).

Let's give Kamala Harris a look-in here. One of her off-the-wall proposals is to introduce taxation of unrealized capital gains. Now, it's clear enough that the immense book wealth of the Musks and Zuckerbergs of this world is a very tempting target for revenue-hungry politicians, but is this really a workable idea? The nature of unrealized gains is that you don't have the cash on hand to pay the tax.  Do you sell assets to pay it, in which case you now have a realized capital gain anyway? Or do you borrow the money, thereby making your balance sheet more risky? 

Does the unrealized capital gains tax apply at all income levels, in which case the impact on small to medium sized entrepreneurship is likely to be severe? Or does it only apply above a certain cutoff point, which no doubt triggers all manner of accounting shenanigans?  And what happens if, after you pay the tax on unrealized gains, you run into a period of losses?  Do you get your money back?

Lastly there's a silly idea that both candidates have embraced: removing income tax on tips.  I blogged about this one back on August 13, so allow me to quote myself: 

Basically, the case not to do this comes down to the good old Law of Unintended Consequences.  One: eliminating taxation on tips directly reduces any incentive for employers to pay their staff a living wage. Two: in all likelihood it reduces the percentage that customers actually tip -- "hey, I've paid tax on this money that I'm tipping you, but you won't be paying tax on it, so it's only fair that I give you less, right?" Three: eliminating taxation on tips creates incentives for smart people to structure their compensation in order to take advantage. Ready to start tipping your investment broker? Just give it time. 

Heck, not just your investment broker.  Your realtor just lowered his fee from 6 percent to 4 percent, but the sales agreement now includes a provision for a 2 percent tip, and that tip is, of course, mandatory.

This is a scary list of dumb ideas, and I'm sure there are quite a few more that I've missed.  We can assume that most of them will never be heard of again after November 5, but the very fact that the candidates are even thinking on these lines is pretty worrisome. 

There's no pleasing some people

Sometimes there's no pleasing the markets, and this seems to be one of those times. Today the BLS reported that headline CPI rose 2.5 percent in August from a year ago -- down from 2.9 percent in July, below market expectations and the lowest reading since February 2021. At first blush that would seem to reinforce the possibility that the Fed will start its easing cycle with a 50 basis point cut later this month.  But no: markets sold off heavily in the wake of the report, with the DJIA falling by as much as 700 points at one stage. 

According to CNN, the seemingly perverse market reaction happened because investors chose not to look at the headline number, but rather to focus on core CPI, which posted a 0.3 percent month-on-month increase, to stand 3.2 percent higher than a year ago. Given the Fed's focus on core measures, that makes some sense. However, another possible explanation suggests itself.  The sharp fall in the year-on-year headline number is largely the result of a favourable "base effect", as large gasoline price increases a year ago fell out of the calculation. Up here north of the border, where something similar has been observed,  the Bank of Canada has been warning that such effects often prove transitory. A similar concern may well be appropriate for the US. 

Prior to today's report, futures markets had been pricing in as much as a one-third possibility of a 50 basis point rate cut this month. That has now been hastily unwound, with a 25 basis point rate cut now seen as by far the likeliest outcome. 

Fifty from the Fed?

How you view the August non-farm payrolls report, released this morning by the Bureau of Labor Statistics,  depends on whether you're a glass half empty or a glass half full type of person. Glass half empty?  Well, the employment gain of 142,000 was lower than market expectations (which had looked for 160,000) and way lower than the 202,000 average posted over the past twelve months.  Glass half full?  The monthly gain was significantly higher than the July result, which was revised lower to a gain of 89,000 from the 114,000 originally reported, and the unemployment rate actually ticked lower, to stand at 4.2 percent.  

The reaction in markets suggests that most investors think the Fed is in the glass half full camp. In recent days expectations had been building that the Fed might front-load its easing cycle with a 50 basis point cut at the FOMC meeting on September 18, but that expectation has now been scaled back, with a 25 basis point cut seen as more likely. 

Fed Chair Powell never seems to be in a hurry. Arguably, both the post-COVID tightening cycle and the still-pending easing cycle should have started sooner. It would be un-Powell-like to start the easing cycle with an oversized cut. That could be interpreted as a sign that the Fed thinks it has fallen behind the curve, and could also create expectations for further large rate cuts. The Fed would undoubtedly prefer to avoid both of those possibilities. Expect a 25 basis point cut this month, with the FOMC statement indicating more of the same to come, while emphasizing that the Fed has flexibility to act more vigorously should the need arise. 

Meanwhile in Canada, where the easing cycle is, as hockey commentators sometimes like to say, nicely under way, the August employment data leave the way clear for further rate cuts. After three months with almost no gain in employment, the economy created 22,000 jobs in August -- but that headline figure hides the fact that 44,000 full time jobs were lost in the month, with the overall gain entirely attributable to a surge in part-time employment.

The unemployment rate continued its inexorable rise, increasing by 0.2 percentage points in the month to stand at 6.6 percent. As has been the case for many months now, the rise in unemployment is almost entirely the result of relentless growth in population. After taking a surprising pause in July, the labour force surged by 82,500 in August, on the back of a 96,000 increase in the national population. 

It helps to look at some of these figures over a slightly longer time frame. Over the past year, the economy has added 316,000 jobs, an increase of about 1.6 percent. In more normal times, this would represent a very respectable performance. However, over the same time period Canada's population has risen by 1,150,000 and the labour force has grown by 588,000. There is no imaginable set of economic policies that would allow the economy to absorb this many new workers. 

Today's data do not change the outlook for Bank of Canada policy. Further 25 basis point rate cuts will come at the two remaining fixed announcement dates this year and the cycle will no doubt continue well into 2025.  However, the Bank will be well aware that it can do little or nothing to prevent the  unemployment rate from edging ever higher. 

Bank of Canada: three and counting

As expected, the Bank of Canada today delivered its third 25 basis point rate cut in the current easing cycle, bringing the overnight rate target to 4.25 percent. Governor Macklem's subsequent statement to the media provides a comprehensive summary of the Bank's policy outlook. In essence, the Bank will "take our monetary policy decisions one at a time", but is clearly biased toward further easing in the coming months. 

Macklem noted that GDP growth in Q2, at a 2.1 percent annualized rate, was faster than the Bank had predicted. It had expected growth to continue to accelerate in the second half of the year, but now sees some downside risk to this, in the form of the reported slowdown in growth in June and July and the lack of employment gains in recent months. Later in the statement, Macklem spells out the policy implications of this outlook: "we need to increasingly guard against the risk that the economy is too weak and inflation falls too much".

In terms of the inflation picture, Macklem sounds reasonably confident: "CPI inflation eased further to 2.5% in July, and our preferred measures of core inflation also moved lower. With the share of CPI components growing above 3% now around its historical norm, there is little evidence of broad-based price pressures". Shelter costs are now the biggest contributor to overall inflation. Rate cuts such as today's will marginally help with this, as floating rate mortgage rates follow the overnight rate lower, but it is unlikely that pressure on housing costs can be meaningfully reduced against the background of a rapidly rising population. 

The Bank sees some risk that unwinding base effects may push headline CPI higher for a time later this  year. It seems likely that the Bank will "look through" this (but good luck persuading the media to do the same)!  "If inflation continues to ease broadly in line with our July forecast, it is reasonable to expect further cuts in our policy rate".  Further 25 basis point rate cuts are likely at each of the Bank's two remaining fixed decision dates this year, and the tone of Gov. Macklem's statement suggests that a 50 basis point cut may happen if the mid-year weakness in the economy shows signs of persisting. 

On it grows, for now

Confounding the doomsayers in the media yet again, the Canadian economy grew at a 2.1 percent annualized rate in the second quarter of 2023. This was (a) faster than the previous quarter; (b) faster than the Bank of Canada's forecast and (c) the fastest pace of growth since the first quarter of 2023. 

GDP growth in the quarter mainly reflected two factors: higher government consumption spending -- no surprise there -- and a welcome surge in business fixed investment, led by spending on transportation equipment. Household spending, which had been very strong in the first quarter of the year, edged lower in Q2, with spending on durable goods falling while spending on food and services continued to increase. 

The fly in the ointment here continues to be per capita GDP, which fell once again in Q2, its fifth consecutive quarterly decline. Since the growth rates recorded in both Q1 and Q2 are not far from most estimates of the economy's potential growth rate, it seems beyond argument that the per capita weakness is the result of excessive immigration rates rather than any underlying structural issues in the economy.  The Federal government seems to be waking up to this reality, proclaiming its intention to curb immigration in the years ahead, but it remains to be seen whether this will help it at next year's election. 

Monthly GDP data were released alongside the quarterly data, and appear to show that the economy had little to no forward momentum at mid-year. After growing 0.1 percent in May, real GDP was unchanged in June, and StatsCan's preliminary data also suggests a flat result for July. This weak "handoff" suggests that growth for Q3 as a whole will be weaker than for Q2. 

There is nothing in today's data to change the Bank of Canada's policy course, with a further 25 basis point reduction likely to be announced on September 4. Market consensus is now calling for similar reductions at the Bank's two fixed announcement dates in October and December. The near-term outlook for slow growth and tame inflation makes that the likeliest outcome, with the easing cycle set to continue into 2025.  

Electric shock

Take a look at this document from the Office of the Parliamentary Budget Officer (PBO) in Ottawa. Over the few years the Federal government, enthusiastically supported by several Provinces, has been firehosing money at manufacturers of electric vehicles, in an effort to persuade them to locate in Canada. As the PBO figures it, a total of C$ 46.1 billion in investments has been announced since 2020 by thirteen manufacturers, including such cash-strapped minnows as GM, Ford, VW and Honda. Remarkably, the total government "investment" to support all of this amounts to almost C$ 52.5 billion.  That's right -- government support actually exceeds the total amount that will be invested in these projects. 

And today we find Prime Minister Justin Trudeau, ramping up the populist rhetoric as his government sinks in the opinion polls, announce that from October 1, Canada will impose a 100 percent tariff on electric vehicles imported from China, which has allegedly ''chosen to give themselves an unfair advantage in the global marketplace".  The stupidity (or is it hypocrisy) is breathtaking, even by Justin's standards. Has  anyone in government paused to consider that if you need massive tariffs even after paying for more than 100 percent of the investment in a particular industry, maybe that's not an industry you can ever be truly competitive in. 

It's true that Canada may not have had much of a choice in this matter. The United States has already imposed 100 percent tariffs on Chinese EVs, and has been leaning heavily on its trading partners to do the same. Locked into the free trade deal with the US and Mexico, and with a new Trump presidency possibly looming, saying no was never a real possibility. What's not clear, however, is that Canada's massive subsidies to the EV industry will pass muster with the incoming US administration, whichever party that may be. Protectionism is never far below the surface in the US, and Canada's subsidies here are egregious in scope. 

In fact, let's hazard a guess at where the first lawsuit may come from. Every Tesla currently sold in Canada comes from a factory in Shanghai and will be subject to the new tariffs come October.  Tesla has somehow contrived not to receive any of the Canadian government's recent largesse.  We await Elon Musk's reaction to today's announcement. 

Much more than a hint

The much-anticipated Fed rate cutting cycle will begin in September. Speaking this morning at the KC Fed's annual Jackson Hole symposium, Fed Chair Jerome Powell made that perfectly clear:

"The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks".

Powell began his remarks by reviewing how recent economic data meant that it was now appropriate for the Fed to worry less about inflation and instead pay more attention to the deterioration in the labour market. It's arguable that this was a decision the Fed could and should have reached before the July FOMC meeting, so it seems very likely that the large downward revision in monthly employment data revealed by the BLS earlier this week played a role in the Fed's timing. 

Be that as it may, the Fed remains confident that it is shifting gears at the right time:

"So far, rising unemployment has not been the result of elevated layoffs, as is typically the case in an economic downturn. Rather, the increase mainly reflects a substantial increase in the supply of workers and a slowdown from the previously frantic pace of hiring. Even so, the cooling in labor market conditions is unmistakable. Job gains remain solid but have slowed this year".

And: 

"With an appropriate dialing back of policy restraint, there is good reason to think that the economy will get back to 2 percent inflation while maintaining a strong labor market. The current level of our policy rate gives us ample room to respond to any risks we may face, including the risk of unwelcome further weakening in labor market conditions".

It is very unusual for a central banker to tip their hand like that, so there can be no doubt that the Fed will follow through with a rate cut at the September 18 FOMC meeting. It remains overwhelmingly likely that the first move will be a 25 basis point cut, rather than anything larger.  There is nothing in Powell's remarks to suggest that the Fed thinks it has fallen behind the curve.  However, the likelihood that each of the two FOMC meetings after September will produce further rate cuts has clearly increased in the wake of Powell's comments today. 

Canada CPI data seal the deal

Canada's CPI data for July, released by Statistics Canada this morning, make it all but certain that the Bank of Canada will implement a further 25 basis point cut in interest rates at its next fixed announcement date, on September 4.  Headline CPI rose 2.5 percent in July from a year ago, down from the 2.7 percent reported for June, marking the smallest annual increase since March 2021.  

The favourable year-on-year outcome owed a great deal to a helpful base effect, as the monthly increases -- 0.4 percent unadjusted, 0.3 percent seasonally adjusted -- were slightly less encouraging. StatsCan drew particular attention to prices for travel tours, which fell 2.8 percent in July, whereas in July 2023 they had risen very rapidly in response to the removal of COVID restrictions. That being said, all of the major sub-components of the headline index are now within the Bank's 1 - 3 percent target range, except for shelter costs, which stood 5.7 percent higher than a year ago as a result of increases in mortgage costs and rents. 

The main special aggregates are also within the target range, with all items except food rising 2.5 percent and all items except food and energy up 2.7 percent.  All three of the Bank's preferred measures of core inflation also moved lower in July, with their mean value falling to just under 2.5 percent.

Beyond the now inevitable September cut, the Bank of Canada's policy actions for the balance of 2024 and into 2025 will remain data-dependent. As long as monthly inflation data remain well-behaved, the Bank's decisions will increasingly be based on the performance of the real economy, and particularly the labour market. In the event that the economy really does tip over into the recession the media have been craving for the last two years and more, the Bank now has much more flexibility to do something about it. 

Hey Kamala and Donald -- here's a tip for ya!

If there's one thing you could probably get most Americans to agree on (and most Canadians too, but that's not relevant here), it's that tipping culture is completely out of hand. Pre-programmed tip amounts on payment devices in restaurants are going ever higher, with most now using 18 percent as a starting point; tip-shaming supposed cheapskates is rising, amid suggestions online that anything less than 28 percent is now entirely unacceptable; and the demand for tips is spreading into more and more workplaces, including some where actual contact between customer and employee is minimal. It's one malign consequence of the pandemic years that shows no sign of abating any time soon.

Now we have both major candidates for the Presidency saying they want to exempt tip income from taxation. Donald Trump suggested it first, but now Kamala Harris is touting the same idea.  And while it may play well on the campaign trail, from any public policy standpoint it's a truly terrible idea.

This article from CNN spells out many of the reasons why that's the case. Basically, the case not to do this comes down to the good old Law of Unintended Consequences.  One: eliminating taxation on tips directly reduces any incentive for employers to pay their staff a living wage. Two: in all likelihood it reduces the percentage that customers actually tip -- "hey, I've paid tax on this money that I'm tipping you, but you won't be paying tax on it, so it's only fair that I give you less, right?" Three: eliminating taxation on tips creates incentives for smart people to structure their compensation in order to take advantage. Ready to start tipping your investment broker? Just give it time. 

Alongside all of these potential downsides, there's the uncomfortable fact that most employees currently in receipt of tips don't earn enough to pay Federal taxes anyway, so there's very little point to all this. Any change in the taxation of tips would require the approval of Congress. The Presidential candidates may ride this dumbass idea right through election day, but it seems unlikely it will ever be implemented.  

Canada's July jobs data: nothing to like

The July employment data released this morning by Statistics Canada make grim reading. True, the unemployment rate was unchanged at 6.4 percent after edging higher for many month, but just about all of the details of the report make grim reading -- and even the unemployment rate may be understated, given the growth in the working age population during the month.  

The economy shed 2800 jobs in the month, with a gain of about 61,000 full time jobs more than offset by a decline of  about 64,000 in part time employment.  The private sector shed 42,000 jobs in the month, while public sector employment rose by 41,000. Over the past year, private sector employment has risen 0.6 percent, against a 4.8 percent rise in public sector jobs.

Some of the big picture statistics provide cause for concern. In line with recent trends, the working age population surged by 125,000 in the month, and yet the labour force supposedly fell by 11,000. Given "normal" participation rates, the labour force might have been expected to rise by about 50-60,000 in the month, which would have pushed the unemployment rate sharply higher. It remains to be seen whether these figures will be revised: recall that Canada's monthly employment figures are notoriously volatile. 

In further evidence of the deterioration in underlying labour market conditions, both the participation rate and the employment rate continued their slow but steady march lower. Aside from some depressed readings in 2020/21 (i.e. the COVID pandemic), the participation rate now stands at its lowest level since 1998. 

All of these numbers point unambiguously to a further rate cut by the Bank of Canada in September.  Given Canada's poor productivity performance, the 5.2 percent annual rise in hourly earnings reported for July (down from 5.4 percent in June) is still way too high for the Bank's comfort. However, it is becoming increasingly clear that the downside risks for the real economy are starting to outweigh the upside risks for inflation. 

Has the Fed fallen behind?

At his post-FOMC media scrum just two days ago, Fed Chair Jerome Powell repeatedly reminded his audience that the Fed's mandate requires it to focus on two goals: maximum employment and stable prices.  He described the Fed's current stance this way: "we weigh those two things equally under the law. When we were far away from our inflation mandate, we had to focus on that. Now we're back to a closer to even focus, so we'll be looking at labor market conditions and asking whether we're getting what we're seeing and as I said, we're prepared to respond if we see that it's not what we wanted to see, which was a gradual normalization of conditions". 

This morning the BLS reported that US employment gains slowed sharply in July, falling to 114,000,  compared to an average of about 170,000 in the preceding three months, pushing the unemployment rate up to 4.3 percent. This was the second-lowest monthly gain, behind only April of this year, since the depths of the COVID slowdown in December 2020. It is generally (and correctly) assumed that the Fed is given a sneak peak at any imminent data releases that may have a major impact on its decision making, so it's hard to believe that it did not have at least a general idea of how today's numbers were going to look. Has it, as Senator Elizabeth Warren stated this morning, "made a serious mistake in not cutting interest rates" this week?

All central banks hate to see their rate decisions turn into political footballs. Chair Powell tried to make it clear at his media conference that the timing of any Fed rate moves this year would not be influenced by anything relating to the Presidential election. (Recall that after the September meeting, where a rate cut is now seen as fully baked in, the next FOMC session begins on November 6, the day after election day).  Perhaps so, but the loud criticism from Senator Warren makes it perfectly clear who stands to lose the most if the Fed gets it wrong. If the much-touted successes of "Bidenomics" are starting to unwind, the impact on the Harris election campaign could be severe indeed. 

A rate cut this past Wednesday would have been something of a surprise, but markets would have fully understood it as soon as today's non-farm payrolls data appeared.  Now, the Fed has placed itself in a truly invidious, "damned if you do, damned if you don't" position. Powell will surely ignore Senator Warren's demand that he "cancel his summer vacation and cut rates now — not wait 6 weeks.” But whatever choice he and the FOMC make from now on (a 25 bp cut in September? -- too little too late!; a 50 bp cut? -- panic stations!) -- will be fodder for the election campaign, a very uncomfortable situation for the Fed. 

With the benefit of just two days' hindsight, it's hard to see this week's rate decision as anything other than an unforced error. 

FOMC verdict: no change, no hints

Despite the recent flow of Fed-friendly data -- easing labour markets, subdued growth in key inflation indices -- markets had little expectation that this week's two-day FOMC meeting would result in a rate cut. And so it has turned out: the Fed has left the funds target range unchanged yet again, at 5.25 -- 5.50%.

If there is any surprise in today's announcement, it lies in the fact that the wording of the media release shows almost no change, though of course Chair Powell may set a slightly different tone when he stands up in front of the media shortly. Most notably, "Inflation has eased over the past year but remains somewhat elevated", and "The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent". 

There is no new "dot plot" for analysts to pore over this time, so those hoping to predict the future must rely entirely on their ability to parse the Fed's words -- words that are not designed to make it easy.  The dot plot from the June FOMC suggested an expectation of one or two rate cuts by year end. Markets seem convinced that the easing cycle will begin with the next scheduled rate announcement on September 18. Beyond that, the remaining two FOMC dates for 2024 are caught up in election season (November 6/7) and the holiday season (December 17/18). Neither of those seems ideal if the Fed wants its moves to register with the public, but it seems likely that the Fed would want to follow up on any September move with a further rate cut on at least one of those dates. Depending, of course, on the data.

Canada GDP keeps chugging ahead

If you rely on information from the traditional media or hellsites like Twitter/X, you can easily get the impression that the Canadian economy is spiralling into oblivion. Private sector debt is unmanageable, fiscal policy is out of control, a wave of mortgage defaults is just about to break....a recession (or worse) is coming -- and that's even before we listen to the more extreme voices that proclaim the data are all fixed and the economy is already in depression.

Thing is, nobody seems to have told the economy, which still seems to act as if it's not dead yet, This morning Statistics Canada reported that real GDP rose 0.2 percent month-on-month in May, following on from the 0.3 percent gain seen in April. Preliminary data suggests a further 0.1 percent rise in June.  Growth in May was broad-based, with a 1.0 percent monthly rise in manufacturing output particularly noteworthy. The data imply that for Q2 as a whole, GDP rose 0.5 percent, or just over 2 percent at an annualized rate, which is more or less in line with most estimates of the economy's long-term potential growth rate.

None of this is to suggest that the Canadian economy is problem-free. In no particular order: private sector debt is indeed way too high (though falling interest rates may help prevent major problems); the country's productivity performance is abysmal; immigration levels are far too high for the country to absorb, with the result that GDP per capita -- i.e., living standards -- is falling despite the continuing growth in aggregate GDP; and the US Presidential election adds a high degree of uncertainty to the outlook, regardless of which party emerges as the winner.

It's a daunting, but perhaps the folks in traditional and social media who have been talking up a recession for more than two years might take a hint from the Sermon on the Mount: "sufficient unto the day is the evil thereof" (Matthew 6:34).

Bank of Canada sets the stage for more rate cuts

In line with market expectations, the Bank of Canada today cut its overnight rate target by 25 basis points, to 4.50%. The accompanying media release, together with an updated Monetary Policy Report (MPR), provide detailed insight into the Bank's current thinking. 

The Bank estimates that GDP growth picked up to 1.5 percent at an annualized rate in the first half of this year. However, this remains well below the immigration-driven level of growth in population and the labour force, which has two important implications. First, per capita GDP -- living standards, if you like -- is falling; second, the economy is moving into a situation of excess supply, which should help to reduce inflationary pressures. The Bank projects real GDP growth of 2.1 percent in 2025 and 2.4 percent in 2026, which should gradually eat into the current excess supply. 

The Bank believes that "broad inflationary pressures are easing". It bases this view on the recent decline in headline CPI growth, as well as the fact that its preferred measures of core inflation are all now running below 3 percent. However, it notes continuing upward pressure from shelter costs, as well as for services, where wage pressures are a significant contributor.

The Bank's analysis of wage pressures is slightly puzzling. In the media release it states that "wage growth is showing some signs of moderating, but remains elevated".  A trawl through the MPR reveals a graph (on page 16) that seems to support the second of those assertions but not the first. Data from the widely-followed Labour Force Survey clearly show continuing acceleration in wage growth, although series from the less well-known SEPH* series (which are also less up-to-date) may just possibly be showing signs of the desired moderation.

The Bank warns that the path of CPI in the coming months may be hard to interpret. It expects headline CPI to slip below the core measures as a result of base effects for gasoline prices, but warns the headline number may then pick up again before "settling around the 2 percent target next year". 

This outlook seems to support the likelihood of further rate cuts before year end, though as ever the Bank cautions that its decisions will be data-driven. The next Governing Council meeting is just six weeks away, on September 4, meaning the Bank will only have one more print of each of the two main series it follows -- CPI and employment -- before it makes its next rate decision.  It seems as if the Bank would like to front-load the easing cycle as long as the data allow it. Two more rate cuts are all but certain by year-end, and there could be more than that. 

* Survey of Employment, Payrolls and Hours

Canada CPI: mostly good news

Canada's headline CPI rose 2.7 percent in June from a year earlier, reversing the slightly worrisome uptick seen in May. On an unadjusted monthly basis CPI actually fell 0.1 percent in June after jumping 0.6 percent in May.  The deceleration in year-on-year inflation was mainly the result of lower prices for gasoline and durable goods. One minor niggle in the report was a small uptick in food price inflation, led by prices for groceries purchased from stores.

Special aggregates generally confirmed that CPI is ever-so-slowly edging towards the Bank of Canada's 2 percent goal. Notably, CPI for all items except food fell 0.3 percent in June to stand 2.6 percent higher than a year ago.  Two of the Bank of Canada's three preferred measures of core inflation edged lower in the month; the mean value of these measures is now almost exactly in line with headline CPI. 

In the wake of today's release, most analysts are expecting the Bank of Canada to deliver another 25 basis point rate cut at its Governing Council meeting on July 24.  This is the likeliest outcome, though the Bank may have some qualms about cutting when the pace of wage increases is above 5 percent, far higher than Canada's anemic productivity growth.  A plethora of strikes across the country -- including, gasp, at liquor stores in Ontario -- suggests that upward pressure on wages is likely to persist. If the Bank delivers a rate cut next week, expect it also to warn that the pace of future reductions may depend on getting wage growth down to more acceptable levels. 

Falling into place

US CPI data for June, released by the BLS this morning, appear to set the stage for the Federal Reserve to start cutting rates as early as September. Headline CPI, which had been unchanged in May, actually fell by 0.1 percent in June, lowering the year-on-year increase to 3.0 percent from May's 3.3 percent reading.  The monthly decline was mainly the result of a fall in gasoline prices. Core CPI (i.e. ex food and energy) also eased marginally in June, rising 0.1 percent after a gain of 0.2 percent in May. This lowered the year-on-year increase to 3,3 percent, the lowest reading for any month since April 2021.  

Although Chair Jay Powell continues to warn that the Fed needs to see further evidence that inflation is moving sustainably toward the 2 percent target, today's data strongly suggest that things are heading in the right direction. In addition to the slowing rise in CPI, the Fed must also take account of the gradual loosening in labor market conditions, reflected in both the non-farm payrolls report and job vacancy data. The lack of any apparent upward pressure on wages should also make the Fed's decisions easier.

At the most recent FOMC meeting in June, the so-called "dot plot" suggested that the consensus of FOMC members now looked for only one or two 25 basis point rate cuts this year. Assuming the next couple of months do not bring a sudden reversal in the recent positive trends, rate cuts in September and December now seem to be the likeliest scenario. 

Canada's jobs market weakened in June

Data from Statistics Canada today show that Canada's employment market weakened in June, both in terms of the headline numbers and the details. This will make it easier for the Bank of Canada to consider another rate cut at the end of the month, although the continued strength in wages may be an issue. 

Employment fell by a negligible 1400 in the month, but this was sufficient to push the unemployment rate up by 0.2 percentage points, to 6.4 percent, exactly one percentage point higher than in June 2023. The factor driving unemployment inexorably higher was once again the immigration-driven surge in the population and the labour force. Canada's population rose by almost 99,000 in the month to stand 1.11 million higher than a year ago, while the labour force grew by 40,000, bringing the year-on-year increase to almost 590,000. 

There is no conceivable way for the economy to create enough jobs to keep up with this growth. even though the increase of 343,000 in total employment over the past year is a strong showing by historical standards.  That fact is reflected in the steady decline in the employment rate, which fell by a further 0.2 percentage points in June to stand at 61.1 percent, 1.1 percentage points lower than a year ago.  Total hours worked also fell in June, falling 0.4 percent, though this measure remains 1.1 percent higher than a year ago. 

Despite the weakness in job growth and the evidence that the pool of available workers is growing fast, wage gains remain too high for the Bank of Canada's comfort, especially in light of Canada's poor productivity performance.  In fact, the year-on-year rise in average hourly earnings accelerated to 5.4 percent in June from 5.1 percent in May  This is the only element of today's report that may give the Bank of Canada pause about cutting rates again in the near term.

Meanwhile in the US, analysts are choosing to view the 206,000 jobs added in June as evidence that job market pressures are slowly easing, an impression reinforced by downward revisions to the data for the two preceding months. One factor that will make the Fed's future rate decisions easier is the subdued growth in wages, with average hourly earnings up just 3.9 percent from a year ago. The Bank of Canada should be so lucky. 

Canada's soft landing

Fresh GDP data released by Statistics Canada this morning suggest that the economy remains on track for the much-desired soft landing. Real GDP, which was unchanged in March, rose 0.3 percent in April, and preliminary figures suggest a further 0.1 percent increase in May.  The growth in April was broad-based, with both goods and services output rising 0.3 percent;  15 of the 20 sub-sectors tracked by StatsCan posted gains. Of note, the manufacturing sector, which had contracted in the two preceding months, posted higher output in both April and May.  

Today's data are unlikely to exert any major influence on the Bank of Canada's rate decision a month from now. Other items on the upcoming release schedule, including employment and CPI data for June, are likely to have much more importance for the Bank. However, there was one other data release today that may keep the possibility of an early rate cut alive.  Payroll employment reportedly fell in April, and reported job vacancies fell in the month, their third consecutive decline. Moreover, the year-on-year increase in average weekly earnings fell to 3.7 percent in April from 4.1 percent in March. This report is not nearly as widely followed as the monthly jobs and unemployment data, but it does appear to support the Bank of Canada's belief that a certain degree of slack is appearing in the labour market. 

While it is good news that the economy is still edging ahead, the kind of GDP growth seen in the most recent three months falls far short of the rate of growth in Canada's population, which continues to be boosted by high immigration levels. Real GDP per head is still falling.  That fact, together with Canada's desultory productivity growth, is sure to be a key issue as and when the next Federal election is called. 

Oops!

Heading into this morning's release of Canada's CPI data for May, the analysts' consensus was looking for another small decline in the year-on-year headline inflation rate, largely on the basis of slightly lower gasoline prices during the month. In the event, the data provided a nasty surprise: headline CPI ticked up to 2.9 percent in May from April's 2.7 percent reading. The details of the report suggest that while inflation pressures are now much less intense than they were a year ago, they remain fairly broad-based, particularly in the services sector. 

Prices for services rose 4.6 percent from a year ago, up from 4.2 percent in April. The increase was partly driven by normal seasonal pressures, for example prices for travel tours and air transportation. Rent also contributed to the monthly increase, and the shelter sub-index is now the fastest growing component of the overall number, rising 6.4 percent from a year ago.  In contrast to the seeming intractability of services inflation, goods prices remain well-controlled, rising 1.0 percent in May from a year ago, the same pace as in April. That said, the 0.9 percent month-on-month jump in food prices will undoubtedly a red flag for policymakers.  

Most of the widely-followed special aggregates tell the same story: all items ex food, up 3.0 percent; ex food and energy, up 2.9 percent; ex energy, up 2.8 percent. As for the Bank of Canada's preferred core inflation measures, two of the three indices ticked higher in May while one moved lower, leaving their mean value at 2.7 percent. All in all it is tempting to conclude that if inflation is indeed stabilizing, it is doing so at a level near 3 percent rather than the 2 percent the Bank of Canada is aiming for.  

What are the policy implications?  The Bank of Canada's recent messaging can be summarized as "if inflation keeps moving lower, we can keep lowering our rate targets".  On that basis, today's data make a July rate cut less likely, and that was certainly the markets' reaction.  However, it is worth noting that June inflation data are due for release on July 16, ahead of the Bank's Governing Council meeting on July 24.  There will also be a full raft of data on the real economy between now and that latter date, including the all-important employment report and another month's GDP statistics.  Those numbers will doubtless play a big role in the Bank's decision-making process, but if nothing else, today's numbers reinforce the message that policy-wise, everything is data-dependent. 

The Daily Telegraph has lost its mind

Actual headlines from the online front page of the London Daily Telegraph, June 13:

• Starmer's first year could be his critics' worst nightmare: a success.
• The people will rise up against Labour's bonkers left-wing agenda.
• Nigel Farage is the Prince Harry of politics, only with cunning.
• The most dangerous part of Labour's manifesto is the bit no-one will read.
• Things can only get smugger as Keir's rock stars take the stage.
• Britain is heading for a populist tsunami far greater than anything seen in Europe.
• Labour is about to give middle England a simple choice: emigrate or give up.
• Keir Starmer is more dangerous than Blair ever was.
• Keir Starmer will destroy England's countryside. Only the Tories can save the Green Belt. 

I really wish I was making these up, Private Eye style, but these are all real, and there will be a similar crop of hatred and nonsense every day* until election day. This is not borderline insanity -- it goes way beyond that. 

* UPDATE, June 14: Just in case you needed further evidence, today's Telegraph brings us this new gem: "Britain still doesn't have a clue about the scale of the disaster heading its way". 

FOMC verdict: not just yet

As expected, the US Federal Reserve today kept its funds target unchanged at 5.25-5.5 percent.  The media release offers some cautious hints that the start of an easing cycle may not be too far in the future. It once again describes current inflation as "elevated", but notes that "there has been further modest progress toward the Committee's 2 percent inflation objective".  Further, "the Committee judges that the risks to achieving its employment and inflation goals have moved toward better balance over the past year".

All of that being said, the release goes on to repeat that "The Committee does not believe it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent". We can get further insight into just what this means for the timing of rate cuts from the latest "dot plot", released as part of the Fed's updated economic projections. It appears that four FOMC participants now expect no rate cuts in 2024, with the remainder (i.e. the majority) looking for one or two 25 basis point reductions.  There is still one lonely holdout expecting no rate reduction during 2025, but the consensus appears to call for rates at the end of next year to be 100 basis points below the current level.

Earlier today, the Bureau of Labor Statistics released CPI data for May, which came in marginally below market expectations. Headline CPI was unchanged in the month, bringing the year-on-year change to 3.3 percent, while CPI ex food and energy rose 0.2 percent in the month for a year-on-year gain of 3.4 percent. Markets reacted very positively to the data and are once again pricing in the possibility of a Fed rate cut as early as September. However, today's numbers are still well above the 2 percent target, and there is little in today's report to change the Fed's judgment that progress back towards that target will be gradual -- a fact that the wording of the FOMC media release and the dot plot clearly underscore. It is all tediously data-dependent, and likely to remain that way for several more months until the inflation picture becomes much clearer. 

Strong and not so strong

The US economy continues to add jobs at a robust pace. Data released today by the BLS show that 272,000 new positions were added in May, well ahead of market expectations for a 180,000 print and above the year-to date average of just under 250,000.  There were minor downward revisions to the March and April data, but there is no doubt that the resilience of the jobs market is now the main factor constraining the ability of the Federal Reserve to start cutting interest rates. 

The May employment gains were concentrated in the services sector, with health care, government and hospitality leading the way. Despite the rise in employment, the unemployment rate ticked up to 4.0 percent, its highest level in more than two years, with some analysts suggesting that the BLS surveys are not fully accounting for immigration levels. One positive from a policymakers' standpoint is that hourly earnings remain reasonably in check, rising 4.1 percent in May from a year ago.

US equity markets sold off in response to the data, reflecting fears that the continuing strength in the economy will further delay the start of the Fed easing cycle. Markets now expect the first and only rate cut for 2024 to take place in December. The FOMC member who was recorded some months ago in the "dot plot" as looking for no cuts at all this year is looking increasingly prescient. 

Canada also recorded higher employment in May, but the details of the report are very ambiguous. According to Statistics Canada, the economy added 26,700 jobs in the month after April's outsize gain of 90,000.  However, full-time employment fell by 36,000 in the month, with the headline increase entirely the result of a 62,000 gain in part-time positions. For much of the recent business cycle, full-time job gains have been a big part of the employment story, but part-time employment is now supplying most of the growth. Part-time employment has risen 3.8 percent over the past twelve months, against a 1.6 percent rise in full-time positions.

Other elements of today's report also point to modestly deteriorating labour market conditions. The unemployment rate ticked up yet again,  to stand at 6.2 percent. Once again it proved impossible for the economy to create enough jobs to absorb the rapid growth in the labour force, which rose a further 54,000 in May to stand over 650,000 higher than a year ago. Moreover, the employment rate -- the percentage of the working age population who are actually employed -- edged down to 61.3 percent, its seventh decline in the last eight months.  

These figures all support the Bank of Canada's decision to start its easing cycle this week, but the wages data are somewhat less helpful for the Bank. Hourly wages rose 5.1 percent year-on-year in May, up from 4.7 percent in April. Given Canada's poor productivity record, it is hard to regard this wage growth as compatible with bringing inflation all the way down to the 2 percent target.

More rate cuts are undoubtedly coming in Canada, possibly as soon as the July 24 Governing Council meeting. With the Fed seemingly on hold sine die, the growing divergence between US and Canadian rates will have to factor into the Bank's decision. Governor Tiff Macklem says he has no target in mind for the exchange rate, but the strength of that conviction may be tested in the months ahead.  

It's a start

Expectations for an early Bank of Canada rate cut strengthened after last week's report of tepid GDP growth in Q1, and today the Bank duly delivered, cutting its overnight target rate by 25 basis points, to 4.75 percent.  This is the first change in the target rate since the Bank ended its tightening cycle in July 2023.

Taking the media release and Governor Macklem's press conference opening statement together, it is evident that the Bank's confidence in continuing easing in inflation has grown in recent months. In the opening statement, Gov. Macklem highlighted four reasons for this belief:

• CPI inflation has eased from 3.4% in December to 2.7% in April

• our preferred measures of core inflation have come down from about 3½% last December to about 2¾% in April

• the 3-month rates of core inflation slowed from about 3½% in December to under 2% in March and April

• the proportion of CPI components increasing faster than 3% is now close to its historical average, suggesting price increases are no longer unusually broad-based.

In addition, the Bank believes the economy is operating in a state of excess supply, so that "there is room for growth even as inflation continues to recede".  It is not clear if the Bank sees evidence of that excess supply only in the labour market. It is certainly true that the unemployment rate has risen steadily in recent months, but that entirely reflects the explosive growth in the labour force resulting from high immigration. It is not yet clear whether the newcomers will quickly settle into productive employment, though the early signs are mostly promising. 

What next? Here we need to parse the Bank's statement carefully. Both the media release and the opening statement say that "monetary policy no longer needs to be as restrictive" (emphasis mine). This implies that it still needs to be somewhat restrictive, and indeed Gov. Macklem stressed that the Bank's future moves will be data dependent: "we are taking our interest rate decisions one meeting at a time". The Bank does not want to keep rates needlessly restrictive, but "if we lower our policy interest rate too quickly, we could jeopardize the progress we’ve made".

This is the vaguest possible forward guidance, and quite deliberately so. The Bank is happy for markets and the general public to conclude that the tightening cycle is over and the easing cycle has begun, but it is not committing itself to any timeline. The emphasis on excess supply suggests that employment figures will be as important as inflation data in determining the pace of easing, and the Bank also has to keep a wary eye on policy developments at the Federal Reserve. At this juncture it looks likely that the Bank will deliver two more 25 basis point rate cuts in the second half of the year. 

Canada GDP clears the way for a rate cut

Canada's GDP data for Q1/2024 appear to leave the way open for the Bank of Canada to deliver a rate cut on June 5. According to Statistics Canada, real GDP grew at a 1.7 percent annualized rate in the quarter, marginally below analyst expectations. Growth for the final quarter of 2023, initially reported as a small  gain, was revised downward to flat.

Details of the report suggest that key segments of the economy continue to show solid growth. Most notably, household spending grew 0.8 percent in the quarter, or over 3 percent at an annualized rate, led by spending on services. This allowed per capita household spending to eke out a 0.1 percent gain, after three quarters of decline. The household savings rate of 7.0 percent was the highest since Q2/2022, suggesting that households will be able to maintain expenditure levels in the near term.

Business capital spending and residential investment also posted gains in the quarter. The main factor that served to keep overall GDP below expectations was a significant slowdown in inventory accumulation. This is generally a volatile component of the report and it is unlikely to represent the start of a new trend.

Alongside the quarterly data, StatsCan also reported monthly GDP figures for March.monthly GDP figures for March. GDP was flat in the month after rising 0.2 percent in February. Of the 20 sectors tracked by StatsCan, 11 posted higher output in the month, with notable gains in construction and the public sector. However, manufacturing output fell 0.8 per cent, mainly as a result of retooling shutdowns. Preliminary data for April suggest GDP grew by 0.3 percent in the month, with broad-based gains.

Today's report is the last major piece of data that the Bank of Canada will see before next week's rate decision, although it is possible the Bank will get a sneak peek at May employment data, which are due for release on June 7.  A 25 basis point rate cut next week may still be a close call, but seems the most probable outcome. However, the Bank will likely stress that it will maintain a cautious approach in the months ahead, with a total of 75 basis points of easing by the end of this year.

It's not the economy, stupid

Back when Bill Clinton was running for re-election as President, he famously had a big sign on his desk that read "it's the economy, stupid". It was there to remind him and his campaign team that pocketbook issues were all-important to the electorate.

Clinton's mantra doesn't seem to hold up any more. There are elections coming fairly soon in three countries that I follow quite closely: the UK in July, the US in November, and Canada on a date yet to be announced, but likely some time in the next twelve months.  The incumbents in all three countries seem very likely to be defeated, even though their economies seem to be doing tolerably well.

Consider. In the UK, the economy has finally emerged from recession and may actually be growing faster than near neighbours such as Germany. Inflation has dropped sharply. It's true that the economy is smaller than it would have been in the absence of Brexit, but given the short memories of most voters, that ought not to count for much any more. In the US, a remarkably high percentage of voters believe the economy is in recession, which is very far from the truth. Inflation is well down from its cyclical peak, though it is starting to look a bit sticky, and unemployment is very low. The fiscal situation is a mess, but when did voters ever care about that? And in Canada, despite the negative tone of much media coverage over the past year, the economy has stayed out of recession. Inflation has come down to the Bank of Canada's target range, likely setting the stage for an interest rate cut as early as next week.

What has changed since Clinton's day?  A few thoughts come to mind. The first is that perceptions of what constitutes a "good" economy have evolved. In Clinton's day it was still common to hear talk of the "misery index", calculated by adding the inflation and unemployment rates together. Evidently that no longer works.  After a couple of decades of persistently low inflation, the surge in prices that resulted mainly from the COVID pandemic was an entirely new experience for much of the electorate, and they didn't much like it. It's true that unemployment briefly spiked higher during COVID, but it's worth keeping in mind that even in a very weak economy, unemployment may only affect 10 percent of the population, whereas inflation is felt by everyone. 

Then there's the change in the availability of information. The days when media outlets employed full-time business reporters who could accurately convey economic data to the public are largely gone.  Looking at inflation again, it would be hard to find an economics writer at most newspapers today who could accurately describe the difference between disinflation (which most countries now have) and deflation (which they don't, and in truth really don't want). News obtained from social media sites is even worse: there seems to be a small army of people out there who see it as their mission to peddle as much disinformation about the state of the economy (and of the world in general) as they possibly can. 

Another aspect of the explosion of social media is the increased polarization of the electorate. Traditional media certainly hosted a wide range of opinions, but the tone was generally respectful and tolerant. Those are not words that can be used to describe the discourse on social media, where innumerable people hide behind their anonymity to post views that would clearly have attracted lawsuits in gentler times. The belligerent tone of social media has, perhaps inevitably, spilled back onto the traditional outlets. Take a look some time at the home page of the London Daily Telegraph -- the paper's columnists are in a scarcely concealed state of rage at the state they perceive the country to be in, and the cataclysm that awaits if the voters are foolish enough to vote Labour in July. (Do yourself a favour and don't read any of the actual articles).

As things stand, it looks as if Messrs Sunak, Biden and Trudeau will all be lined up at the unemployment office the day after voting day, despite the healthy-ish economies they oversee. It's not as if their likely replacements are at all inspiring -- in the UK, Keir Starmer is dull and unambitious; in the US, well, nothing to add here; and in Canada, Pierre Poilievre is a shrill right-winger with no real-world experience to speak of. In all three countries, it looks like change for change's sake is what the voters want. 

That should do it

Canada's headline consumer price index (CPI) rose 2.7 percent in April from a year ago, the slowest annual increase in just over three years, according to data published by Statistics Canada this morning. The details of the report suggest that the way is now open for the Bank of Canada to start the long-awaited easing cycle at its Governing Council meeting on June 5.

The three "usual suspects" that have been largely responsible for pushing CPI higher in the current cycle are now down to two. Gasoline prices were up 6.1 percent year-on-year in April, up from 4.5 percent in March; this reflected the usual switch to more expensive summer blends and the Federal government's carbon tax increase at the start of the month. Shelter costs also continue to rise rapidly, advancing 6.4 percent from a year earlier.  High mortgage costs and pressure on rents from rapid, immigration-driven population increases are behind the continued pressure in this category. 

It is, however, a different and more encouraging story for food prices, the source of so much angst for both consumers and the government over the past year. The annual increase for food purchased from stores slipped to 1.4 percent in April from March's 1.9 percent reading.  The Federal government has made a big show of putting pressure on the large supermarket chains to keep food prices down, proposing to introduce a grocery "Code of Conduct". Can the government now legitimately claim credit for the fall in food price inflation? Well, just this week the largest of the supermarkets, Loblaw, announced it would be willing to sign up to the Code of Conduct after strongly opposing it for many months. The most likely explanation is that the company now believes that the underlying cost pressures that it has always blamed for higher in-store prices have now abated, which has very little to do with the government. 

The Bank of Canada's favoured measures of core inflation are also reflecting the waning of price pressures. All three of those measures now stand below 3 percent -- that is, within the Bank's 1 - 3 percent target range -- with their mean value at 2.7 percent. 

All in all, today's data will likely allow the Bank to implement a 25 basis point rate cut in early June.  However, it is probable the Bank will signal that it will proceed cautiously from there: consumers and markets should not expect further cuts at every Governing Council meeting for the rest of the year. With inflation still above the midpoint of the target range and the US Fed unlikely to cut the funds rate much before year-end, the Bank is unlikely to cut rates by more than 75 basis points in aggregate this year. 

Strong jobs data -- not helpful!

So a month ago, Statistics Canada announced that the economy shed more than 2,000 jobs in March, with the unemployment rate jumping to 6.1 percent.  In the minds of both analysts and the media, this seemed to lock in the case for a rate cut by the Bank of Canada on June 5; more recent announcements from the US -- slowing employment growth, rising initial jobless claims -- appeared to suggest that a rate-cutting cycle might soon be underway south of the border too.

That consensus has been put into doubt by Canada's April employment data, released this morning by Statistics Canada. Employment rose a staggering 90,000 in the month, way above all expectations. Despite that increase, the unemployment rate was unchanged at 6.1 percent as the labour force continued its torrid growth, rising more than 107,000 from the preceding month. Even allowing for the customary extreme volatility of Canada's employment data, the headline numbers certainly cast doubt on the likelihood of an early rate cut.

Media coverage of the data has quickly focused on the fact that 50,000 of the new jobs were part-time in nature. True enough, but this may be something of an aberration: for the past year as a whole, full-time employment has risen by 272,000, compared to only 104,000 new part-time positions.  The standard critique, that it is only the public sector that is creating jobs, also does not apply, as 50,000 of April's new jobs were in the private sector, with a further 14,000 representing self-employment. 

One welcome development from a policy standpoint is that wage growth slowed in the month. Average hourly earnings rose 4.7 percent year-on-year, down from the 5.1 percent gain recorded in March. However, given Canada's lamentable productivity record, that still seems too high for the Bank of Canada's comfort.

Expectations for a June rate cut, and the relief it will bring for mortgage borrowers, have been firmly locked in for some time now, and the Bank will be wary of crossing up the markets.  However, it appears that the April CPI data, due for release on May 21, may now be the crucial factor in determining whether that early rate cut happens. Recall that headline CPI ticked up to 2.9 percent year-on-year in March, with unexpectedly strong month-on-month gains. Another negative surprise in the April data could well push the start of the rate-cutting cycle back to the following Governing Council meeting, set for July 24. 

Fed holds the line but tapers the taper

As expected, the FOMC today kept the Fed funds target unchanged at 5.25 - 5.5 percent, while clearly suggesting that it is still some way from being ready to start an easing cycle. It also significantly reduced the pace of its quantitative tightening program, presumably in order to prevent the possible emergence of a liquidity squeeze. 

The phraseology of the media release its in many respects similar to what we have been seeing for the past several months:  "economic activity has continued to expand at a solid pace. Job gains have remained strong, and the unemployment rate has remained low. Inflation has eased over the past year but remains elevated" . However, the very first paragraph ends with a new and unequivocally bearish warning: "In recent months, there has been a lack of further progress toward the Committee's 2 percent inflation objective".

Given that warning, it is no surprise that the media release goes on to say, as usual, that "The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent".  There is no new "dot plot" for analysts to pore over this time, but with a June rate cut now apparently off the table, it seems certain that the consensus of FMC members is now looking for something much smaller than the 75 basis points of easing that was previously forecast for the remainder of 2024. The outlying view that there might be no rate cuts until 2025 no longer seems so improbable.

There have been growing concerns in fixed income markets that the rapid pace of the Fed's quantitative tightening (QT) might lead to liquidity issues in the banking system. Today's announcement that the QT for Treasury securities will be cut from $60 billion/month to $25 billion per month should allay these fears. However, this is the only remotely bullish thing about today's announcement. Fears that the Fed might actually have to start raising rates again seem overblown, but for now, the easing cycle seems sure to start later and be more gradual than markets were hoping. 

Accelerating into a recession?

I'm almost embarrassed to be criticizing media coverage of the Canadian economy again, but the denizens of the newsrooms leave me very little choice. This morning Statistics Canada reported that real GDP grew 0.2 percent in February, compared to a downward-revised increase of 0.5 percent in January. The preliminary estimate for March is that real GDP was almost unchanged in the month.  Markets immediately interpreted the data as clearing the way for the Bank of Canada to deliver a rate cut at its next Council meeting on June 5.  That's probably still the correct call, but the picture is not quite as simple as the headline numbers (and the media) make it look. 

StatsCan estimates that real GDP growth for Q1 as a whole will probably come in at 0.6 percent quarter-over-quarter, or an annualized rate of about 2.5 percent. That's significantly stronger than the anemic 0.2 percent quarter-over-quarter growth rate reported for the final quarter of 2023.  It's also pretty much in line with most estimates of the economy's long-term potential growth rate. That suggests that if the economy is moving into a situation of excess supply, which would be disinflationary, it's doing so at a glacial pace. 

The slowdown in monthly growth from January to February and seemingly again from February to March may be significant, but it needs to be interpreted carefully.  The strong number posted for January was heavily influenced by the end of public sector strikes in Quebec.  The underlying pace of growth in the economy is probably somewhere between the February and March numbers, hardly a robust showing but not one that points unequivocally to an imminent recession. The February report would in fact have been higher but for a pullback in utilities output in the month, reflecting the unusually mild winter weather across most of the country this year.

Where does this report leave the policymakers at the Bank of Canada? The estimated quarterly figure is more or less in line with the Bank's most recent forecasts, and it is important to recall that the Bank expects GDP growth to accelerate as the year progresses. The latest inflation data showed an unwelcome uptick, which the Bank will not want to see repeated when the April figures are reported in mid-May. Lastly, there is increasing speculation that the Federal Reserve will not start reducing rates until September or even December, and the Bank will not want to untether Canadian rates too completely from those in the US, for fear of causing the exchange rate to weaken sharply. 

In short, it's still not an easy choice. Barring a very nasty inflation surprise, a 25 basis point rate cut in early June is still the likeliest outcome, but it now seems unlikely that the Bank will be able to follow up with further cuts at each of its meetings in the second half of the year.  

  

Canada's Federal budget: anchors aweigh

Justin Trudeau became Prime Minister of Canada in October 2015 partly on a promise to run small fiscal deficits for just a few years in order to boost the economy.  There was always supposed to be a plan to move the budget back into balance, and in the meantime the debt/GDP ratio would serve as a backstop fiscal anchor to keep deficits and debt from getting out of hand. It became clear quite quickly that the deficits would be bigger and more persistent than Trudeau had intimated -- and then came the COVID crisis, to which the government quite correctly responded by hugely boosting spending and the deficit. 

As the threat from COVID eased, the budget deficit began to fall quite rapidly, but in the last couple of years Trudeau and his Finance Minister Chrystia Freeland have made it clear that they have no intention of reining in the government's finances. The 2024 Federal budget, unveiled by Freeland on Wednesday, indicates that all of the fiscal checks and balances promised back in 2015 have been abandoned.

You can read a summary of the government's proposals here. As promised in Trudeau's pre-budget cross-Canada tour, there is heavy emphasis on measures to boost housing availability and affordability  -- in effect, attempting to solve problems that have in large measure been created by the government's own out of control immigration policies.  There are a few revenue-raising measures, of which the most significant is a boost in capital gains taxes. This is supposed to raise something like C$ 20 billion, even though it is targeted only at the wealthiest 0.13 percent (really!) of taxpayers.

The end result of this is a string of deficits stretching out over the usual five-year planning horizon. The deficit for the just completed fiscal year 2023/24 was C$ 40.0 billion. It is projected to be remarkably sticky this year and next, at C$ 39.8 billion in FY 2024/25 and C$ 38.9 billion in FY 2025/26.  After that, the deficit magically starts to fall much faster, but even by the end of the planning period, FY 2028/29, it is still projected to be C$ 20.0 billion. Every single one of these numbers is higher than was projected in the Fall Economic Statement back in November. And the fact that the deficits seem to fall faster in the "out years" is of course completely bogus, with an election due by October 2025 at the latest. We seem to be back to the kind of budgetary forecasting that got Canada into a fiscal mess under Tory governments back in the 1990s.

There is nothing wrong with deficit financing in principle. The idea that deficits always cause inflation is wrong; so is the idea that government financing needs "crowd out" private sector borrowers. And anyone who followed the ill-fated austerity approach followed by the UK government after the global financial crisis surely knows that you can never correct a budget deficit by squeezing the economy. The only true constraint on the economy is the availability of real resources, be they labour, capital goods or raw materials. As Keynes famously put it, "anything we can do, we can afford".

That's precisely the issue here. The Bank of Canada has had to keep interest rates uncomfortably high for a long time because the economy has been running very close to full capacity, or full resource utilization if you prefer. Bank Governor Tiff Macklem has subtly suggested more than once that high  government spending has made the task of reducing inflation much harder than it needed to be. 

It's arguable that the recent uptick in the unemployment rate has eased some of those concerns, something the Bank has acknowledged in its policy pronouncements.  However, it is not clear that the pool of available workers, which largely consists of new arrivals and job-seeking college graduates, matches the current needs of the economy. To take just one example, the budget's commitment to build over 3 million homes by 2031 is going to require an awful lot of skilled construction workers. It is not at all clear where those people will be found. 

Announcing its most recent monetary policy decision, the Bank of Canada projected that the economy would start to move out of its recent mini-slump after mid-year. As a result, the small amount of excess supply that has emerged over the past several months will quickly be eliminated, which would serve to put a floor under just how low the Bank can lower interest rates without reviving inflationary pressures. This Federal budget, which has been roundly condemned by such worthies as former Finance Minister Bill Morneau and former Bank of Canada Governor David Dodge, looks certain to continue to make the Bank's job more difficult in the coming years.

What a choice Canadians face when the election finally rolls around. The abrasive Tory leader Pierre Poilievre and his seriously inexperienced team, or the experienced but reckless Trudeau/Freeland combo. Polls say the election is Poilievre's to lose, and there does not seem to be much in the budget to change that.