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.