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.