FOMC announcement: no change and no real hints

As expected, the US Federal Reserve today kept the funds target unchanged at 5.25-5.5 percent, while offering little in the way of guidance as to when any rate cuts might start to happen.  The Fed's view of the current state of the US economy is unchanged:

Recent indicators suggest that economic activity has been expanding at a solid pace. Job gains have moderated since early last year but remain strong, and the unemployment rate has remained low. Inflation has eased over the past year but remains elevated.

It is impossible to question any part of that summary. Indeed, the startling real growth rate reported for Q4 GDP makes "a solid pace" seem like an understatement.  Job growth continues to surprise to the upside, and the latest CPI data seem to confirm that the last stretch of getting inflation back to the 2 percent target is likely to prove the toughest. 

The uncertainty over inflation is clearly top of mind for the FOMC, which again reminds its audience that it "is strongly committed to returning inflation to its 2 percent objective".  The press release also includes a direct response to the media and market speculation over a possible early start to the easing process:  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. 

That statement at least suggests they are starting to think about rate reductions, but remain far from being able to give any firm guidance as to timing. Given the state of the economy, it is hard to see why they need to be in any rush to cut.  The likeliest scenario continues to be one in which rates stay at the current level for the first half of this year, with the 75 basis points in reductions suggested by the most recent "dot plot" still in prospect by year-end.  

No recession is no news

At 8:30 EDT this morning, Statistics Canada released data for real GDP for November and, on a preliminary basis, December 2023. Half an hour or so later, I checked the website of the major news outlets to see how they were covering the release.  They pretty much weren't covering it at all, which could only mean one thing: the recession that the media have been baying for since about mid-2022 failed to show up yet again.

If we look at the actual data release, we find that real GDP grew 0.2 percent in the month of November, higher than the preliminary estimate of 0.1 percent,  after remaining virtually unchanged for the three preceding months.  The growth was broad-based, led by the goods-producing sectors, which posted a 0.6 percent month-on-month gain. Thirteen of the twenty sub-sectors tracked by StatsCan saw higher output in the month.  Moreover, StatsCan's preliminary estimate for December suggests that the economy accelerated further in the month, with real GDP posting a 0.3 percent increase.

These monthly numbers are calculated on a slightly different basis from the quarterly data and are of course subject to revision.  Even so, StatsCan feels able to offer an estimate for how the quarterly number for Q4, not due until February 28, is likely to turn out.  It estimates that real GDP grew 0.3 percent in the quarter, which annualizes to around 1.2-1.3 percent.  That would more than offset the 1.1 percent annualized decline reported for Q3. 

Even if these numbers are revised, it is clear that a recession has, yet again, failed to materialize -- indeed, the November and December data would appear to show that the economy is actually starting to move away from such an outcome. A check back with the major news outlets a few hours after the data were released showed they were at least deigning to report the figures, though not in large type and not without adding an editorial comment or two. The Toronto Star's story, for example, is headlined "The Canadian economy grew slightly in November".  In fact, the 0.2 percent gain reported for November annualizes to about 2.5 percent, in line with the economy's long-term potential, and December's 0.3 percent annualizes to a rate close to 4 percent, considerably above potential.  But that wouldn't be newsworthy, would it?

Bank of Canada: "we're getting there"

The Bank of Canada today kept its overnight rate target at 5 percent, in line with unanimous market expectations.  The press release is mostly a listing of factors that are starting to line up for eventual policy easing, followed by a brief  paragraph explaining why it's not yet time to make a move.  The Bank has also published an updated Monetary Policy Report today, and Governor Macklem's introductory remarks give more insight into how the Governing Council is currently thinking.

Let's start with the press release. After an opening paragraph that simply states the Bank's decision, we get two paragraphs on the global growth picture.  Key quotes: "While growth in the United States has been stronger than expected, it is anticipated to slow in 2024".  This is of course key for the Canadian economy and for policymakers, given the overwhelming importance of the US to Canada's external trade sector.  "The Bank now forecasts global GDP growth of 2½% in 2024 and 2¾% in 2025, following 2023’s 3% pace. With softer growth this year, inflation rates in most advanced economies are expected to come down slowly, reaching central bank targets in 2025". It is, of course, important for the Bank not to get its policy cycle too far out of line with the rest of the world, so the expectation that other central banks will soon be in a position to cut certainly makes its job easier. 

We then move on to two paragraphs on the domestic economy.  Key quotes: "the economy has stalled since the middle of 2023 and growth will likely remain close to zero through the first quarter of 2024....the economy now looks to be operating in modest excess supply.....However, wages are still rising around 4% to 5%". That final quote about wages is the first indication of the Bank's lingering concern that slower growth has not yet created conditions for lower interest rates. "Economic growth is expected to strengthen gradually around the middle of 2024.... Spending by governments contributes materially to growth through the year. Overall, the Bank forecasts GDP growth of 0.8% in 2024 and 2.4% in 2025, roughly unchanged from its October projection".  Once again we see the Bank complaining, albeit gently, that relentlessly expansionary fiscal policy is not making its job any easier. 

Finally we get a paragraph on inflation, explaining why it is still too soon to cut, even if the stars are coming into alignment. It's worth quoting the full paragraph:

"CPI inflation ended the year at 3.4%. Shelter costs remain the biggest contributor to above-target inflation. The Bank expects inflation to remain close to 3% during the first half of this year before gradually easing, returning to the 2% target in 2025. While the slowdown in demand is reducing price pressures in a broader number of CPI components and corporate pricing behaviour continues to normalize, core measures of inflation are not showing sustained declines". 

Shelter costs are at least partly under the Bank's direct influence because of the role played by mortgage costs, but it is arguable that rapid, immigration-driven population growth is a bigger factor. You might think that the statement that "core measures of inflation are not showing sustained declines" would lead the Bank to question whether the fall in headline CPI might not, in fact, have been brought about by Bank policy moves, and is instead mainly the result of supply chain normalization.  Needless to say, that's not how the Bank sees it. 

The final paragraph spells out what the Bank is looking for in the months ahead. "Governing Council wants to see further and sustained easing in core inflation and continues to focus on the balance between demand and supply in the economy, inflation expectations, wage growth, and corporate pricing behaviour".

It's hard to judge from that just how close the Bank is to starting an easing cycle, but Governor Macklem's opening remarks are rather more explicit: 

"...monetary policy is working to relieve price pressures, and we need to stay the course. Inflation is coming down as higher interest rates restrain demand in the economy. But inflation is still too high, and underlying inflationary pressures persist. We need to give these higher rates time to do their work.

...with overall demand in the economy no longer running ahead of supply, Governing Council’s discussion of monetary policy is shifting from whether our policy rate is restrictive enough to restore price stability, to how long it needs to stay at the current level". 

Setting aside the Bank's apparent belief that it can claim all the credit for lower inflation, it's clear that these paragraphs continue the recent trend towards softer rhetoric about the rate outlook.  Monthly GDP data for December, due for release a week from today (i.e. January 31) should give a clearer reading on whether the economy has already slipped into a mild technical recession. If it has (and the guess here is that it hasn't, but it might be very close), calls for early rate cuts are certain to intensify.  The Bank is highly unlikely to respond, but the tone of today's releases suggests the easing cycle may start a bit earlier than previously seemed likely.  Waiting until June still makes good sense, but April can no longer be ruled out. 

A Lob-Law unto themselves

Back in the summer of 2023, the Canadian Government summoned the heads of the major grocery chains in Canada to a meeting in Ottawa, demanding that they do something to reduce the rate of food price inflation.  If we're naming names, there were five chains at the meeting -- three Canadian-owned (Loblaws, Metro and Sobey's) and two US-owned (Costco and Walmart).  

The pace of food price inflation has in fact fallen sharply since that first meeting, though there's no evidence that the pressure from the government had much to do with it. The Government has tried to keep the issue on the front pages, even going so far as to hint that it was trying to attract a foreign grocery chain into the Canadian market to increase the level of competition, a bizarre thing for any national government to do. It has also announced its intention to impose a legally-binding Code of Grocery Conduct on the existing quintet.

For the most part, the CEOs of the five firms have largely suffered through all this posturing in silence, with one exception. Loblaws CEO, the multi-billionaire Galen Weston, has been visibly angry about the whole process, blaming the rise in food prices during and after the pandemic mainly on the company's suppliers. He has also begun to warn that the Code of Grocery Conduct as currently propose will tend to push prices even higher, not lower them. 

This week we have found out why Galen can be so confident about this outcome. Loblaws has announced that it will be ending its current practice of cutting the prices of soon-to-expire food items -- bread. veggies, prepared meals and such -- by up to 50 percent in order to get them off the shelves. It portrays this deeply cynical move in an even more deeply cynical way, as providing "more consistency with our competitors".  I don't know about you, but I have generally thought that competition is supposed to help keep prices down, not provide cover for putting them up, but here we are.

As the linked article suggests, this looks a lot like collusion to a lot of people, although one of the quoted experts suggests it is "conscious parallelism" -- watching your competitors and imitating them.  Fair enough, but the timing of this, coming after all the meetings with the government and the threat of the Code of Grocery Conduct, looks very much like Loblaws flipping the bird at the government.  If Galen Weston actually wants a Piggly-Wiggly, or more likely an Aldi, across the street from one of his stores, he's going the right way about it.

UPDATE, January 20:  Well, here's a thing you don't see every day!  Loblaws has reversed its decision to eliminate the 50 percent discount as a result of the uproar its initial announcement caused.  Well done, Galen Weston, but next time, "measure twice, cut once".

Canada December CPI: nothing (much) to see here

Data released by Statistics Canada today show that headline consumer prices rose 3.4 percent in December from a year ago, after increases of 3.1 percent in the two preceding months. The uptick was largely expected by analysts, and reflects some slightly tricky quirks in the calculation, so pay attention at the back there.

The CBC website headlines its report on the data thus: "Gasoline prices help drive inflation up to 3.4 percent".  Except, guess what, gasoline prices actually fell in December, dropping 4.4 percent from the previous month.  The thing is, gas prices dropped even more sharply than that in December 2022, so what actually happened in December 2023 was an example of the so-called "base effect". The shift in the headline year-on-year number had more to do with what happened a year ago than with what is happening now.  Just to underline that point further, headline CPI (not seasonally adjusted) actually fell 0.3 percent month-on-month in December, a fact that does not seem to have registered with the headline writer. 

Stripping out gasoline prices, the inflation rate actually eased slightly in December, falling to 3.5 percent from the previous month's 3.6 percent reading. Shelter costs continue to exert upward influence on the overall price level, rising 6.0 percent from a year ago, led by a 7.7 percent increase in rents. The Bank of Canada's three preferred core inflation measures showed little change in the month, although one of the three, CPI-trim, edged slightly higher.

There is not much in today's data to change the Bank of Canada's thinking about the future course of interest rates. It remains the case that key measures of inflation are too far above the 2 percent target to allow for any early rate reductions, however enthusiastic markets may be about that prospect. The Bank's Survey of Consumer Expectations for Q4/2023, published on Monday, notes that Consumers perceive inflation to have decreased, and their expectations for price growth for some key goods such as food and gas have moderated.  That's obviously welcome news, except that the report goes on to say But near-term inflation expectations have barely changed, a fact that the Bank attributes to high expectations for inflation in services such as rents. As long as the economy keeps puttering along without slipping into recession, the Bank will likely prefer to hold off on rate cuts for much of this year. 

Not so fast!

It has been quite clear, at least to this blogger, that markets have been getting ahead of themselves in pricing in rate cuts by the US Federal Reserve.  December CPI data, released today by the Bureau of Labor Statistics, confirm that the Fed still has work to do. 

Headline CPI rose 0.3 percent in December as gasoline prices, which had been contributing to lower readings in recent months, showed little change.  The year-on-year increase ticked up to 3.4 percent in December from 3.1 percent in November.  Both the monthly and annual increases were in line with market expectations and are unlikely to have any major influence on the Fed's decision-making in the near term. 

Core inflation, however, is a different matter. CPI ex food and energy rose 0.3 percent in December, the same increase as in November.  This allowed the year-on-year rate to edge down to 3.9 percent in December from the previous reading of 4.0 percent.  This is the smallest increase in year-on-year core CPI since May 2021.  While that certainly counts as good news, it is still well above the Fed's inflation target, and the month-to-month changes, which annualize to almost 4 percent,  clearly suggest that core inflation is proving to be stickier than the headline measure. 

The Fed's regularly stated position that it will only start cutting rates when it is sure that inflation is heading sustainably back to the 2 percent target. The fact that the US economy still seems to be firing on all cylinders means that there is no need to start the cutting cycle prematurely, whatever the markets may think.  For now, the 75 basis points in cuts foreseen in the latest "dot plot" still seem like a reasonable projection, but the first cut is unlikely to arrive much before mid-year. 

December divergence

The first major data releases of the new year told differing stories about the state of the Canadian and US economies.  While employment growth in Canada has clearly slowed in response to the recent stagnation in real GDP, the US economy continues to add jobs at a rapid pace.  In both countries, however, continuing wage gains are likely to work against early rate cuts. 

In Canada, Statistics Canada reported that employment in December was almost unchanged from the previous month, with the net addition of a scant 100 jobs. (The significance of this can perhaps best be judged by noting that the standard error of the estimate is over 30,000)!  The report was in fact slightly weaker than the headline figure suggests, as a gain of 23,600 in part-time employment was offset by a loss of 23,500 full-time positions. Despite this, and somewhat perplexingly, total hours worked actually rose 0.4 percent in the month.

After rising steadily for much of the year, the unemployment rate was unchanged at 5.8 percent in December.  This can be entirely attributed to a sudden slowdown in the previously rapid growth in the labour force, which grew by only 4,800 in the month, well below the monthly average of 52,000 posted over the course of the year.  Given that the population grew by 74,000 in December, this is almost certainly only a temporary reprieve. 

The slowdown in employment growth will no doubt heighten expectations of early Bank of Canada rate cuts, but there is one key element of the data that will give the Bank pause. The year-on-year rise in hourly earnings rose to 5.4 percent in December from 4.8 percent in November. Given Canada's generally weak productivity performance, this seems way too high to ensure that headline inflation moves sustainably towards the Bank's 2 percent CPI target.  In the absence of a sudden severe turndown in the real economy, it remains likely that the rate cutting cycle will not begin much before mid-year. 

Turning then to the US, where opinion pollsters continue to report that voters are overwhelmingly dissatisfied with the state of the economy, we find that the economy added 216,000 jobs in December. This left the unemployment rate unchanged at 3.7 percent. There was a slight uptick in wage growth, with a 0.4 percent monthly gain pushing the year-on-year increase in hourly earnings up to 4.1 percent from the 4.0 percent rise reported for November. This is well above the latest rise in CPI, not that voters seem to have noticed. 

Unsurprisingly, while President Biden has welcomed the latest data ("a great year for American workers"), financial markets have been less impressed.  Even as inflation heads lower, the strong job gains and persistent strength in earnings make it likely that the Federal Reserve will opt to hold off on rate cuts.  There is simply no reason for the Fed to start cutting until it is completely sure that inflation is heading back to the 2 percent target.  The 75 basis points in rate cuts implied by the most recent "dot plot" may indeed materialize, but as in Canada, they are unlikely to start before mid-2024.