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.