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. 

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. 

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. 

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.

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. 

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.  

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. 

Disturbing data divergence

Data from the Bureau of Labor Statistics show that US employment rose by 303,000 in March, far surpassing economists' expectations. (Details here).  This has triggered the usual debate among media pundits about why US voters still seem to have such a negative view of the economy. The answer this month, as it has been for the last year and more, is inflation. In a low unemployment economy, almost no-one is concerned about losing their job, but everyone sees that prices are much higher than they were before the "transitory" inflation spike began.  We can but live in hope that the media will figure this out eventually.

Meanwhile in Canada, the March data tell a very different story. According to Statistics Canada, the economy actually lost a little over 2000 jobs in March. This is well within the standard error of the estimate -- remember, this is a survey, not a complete count -- but it comes at a time when the labour force is still growing at an extraordinary pace. Canada's population grew by 90,000 in March, to stand more than 1,040,000 higher than a year earlier.  The labour force grew by 57,000 in March and is now 570,000 larger than a year ago.

Looking at these numbers in percentage terms, we find that even with the marginal decline in March, employment has grown by 1.6 percent in the past year, by no means a bad number.  However, this is far outpaced by the growth in population -- up 3.2 percent from a year ago -- and the labour force, up 2.7 percent in the same time period. It is thus no surprise to find that the employment rate has been going down -- it now stands at 61.4 percent, down 0.9  percentage points from a year ago -- and the unemployment rate has been steadily rising. That rate jumped 0.3 percentage points in March to hit 6.1 percent, a full percentage point higher than it was a year ago.

The Bank of Canada will not want to react too much to a single data point, especially given the notorious volatility of Canadian job statistics. However, today's data will certainly add to the growing calls for the Bank to make an early start on the much-anticipated rate cutting cycle. One problem there: wage growth actually ticked slightly higher in March, to 5.1 percent year-on-year, an uncomfortably high number given Canada's very poor productivity performance. The first rate cut is still not likely to materialize before June, but it looks likely that the Bank will have to cut more aggressively than the Fed, which will probably put pressure on the exchange rate.

The rising unemployment rate is not good news for Justin Trudeau, who has been whirling around Canada like a dervish, announcing major new spending ahead of the April 16 budget. This week he directly addressed the impact of high immigration levels, telling an audience in Nova Scotia that the growth in "temporary" immigration has been "far beyond what Canada has been able to absorb". Wow!  If only there was someone out there in a position to see that coming and do something about it -- you know, a Prime Minister or something such. 

FOMC: ever so slightly more dovish

In line with almost unanimous market expectations, the Federal Reserve today kept the Fed funds target range unchanged at 5.25 - 5.50%. The press release continues to describe inflation as elevated, but there is one significant change in the language: the FOMC now "judges that the risks to achieving its employment and inflation goals are moving into better balance". 

As ever, there is no clear hint as to when an easing cycle might begin. One key sentence carried over verbatim from the last press release suggests the Fed is still in no hurry: "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".  Given that headline CPI edged higher in February, and considering the steady upward pressure on global oil prices, it is no real surprise to find that market expectations for the extent and timing of rate cuts have been scaled back in recent weeks.  

The Fed has also released an updated Summary of Economic Projections.  Inflation (measured using the core PCE deflator) is not expected to fall al the way to the 2 percent target until 2025 at the earliest.  However, the closely-followed "dot plot" shows that about half of the participants in the FOMC still expect three 25 basis point rate cuts by the end of the year -- though, strikingly, two participants expect no reduction at all this year, and one does not even expect a cut in 2025.  

The takeaway from all this is that despite some softening in the Fed's language, a clear move toward easier policy is still some way away.  A rate cut at the June FOMC meeting, which until recently was the consensus expectation, now looks like the earliest possible timeframe for any sort of easing move. 

Hot and hot

North American markets and mass media have been full of speculation about the timing of central bank rate cuts for months.  After all, headline inflation readings have been heading lower for a year and more, with the target levels -- 2 percent for both the Fed and the Bank of Canada -- now coming into view.  Central bankers have warned -- largely in vain, it would seem -- that they need to see lower inflation being sustained before they can contemplate easing monetary policy.  The state of the two countries' job markets, both in terms of employment and wage growth, is evidently one of the indicators being followed most closely in both DC and Ottawa.

With that in mind we can turn to the February employment data for both countries, released before markets opened this morning. In the US, non-farm payrolls rose by 275,000, beating market expectations for a gain of 200,000.  That's a strong headline number, albeit partly offset by the fact that the previously-reported employment gains for December and January were revised lower by an aggregate of 165,000 jobs. 

Despite the headline strength, the details of the report convey a different impression: there is no real evidence that job market conditions are tightening.  The employment rate (i.e. the ratio of employment to population) edged lower in the month, while the unemployment rate ticked up to 3.9 percent.  Equally important, average hourly earnings rose only 0.1 percent in February, to stand 4.3 percent higher than a year earlier.  This may still be a little too high for the Fed's comfort, but it does not suggest that wages will be the factor that keeps inflation from falling to the target level in the months ahead.  

All in all, today's data suggest that the stars are coming into alignment for the Fed to star cutting rates some time this year.  However, the continuing resilience of the labour market means policymakers need not be in any hurry. A mid-year start to the rate cutting cycle, with about 75 basis points of easing by year-end, still seems the likeliest outcome.  

Turning to Canada, we find an equally hot, if not hotter headline number, but with some very different trends going on under the surface.  The economy added 40,700 jobs in February, following on from the 37,000 gain posted in January. Moreover, while the January figure largely reflected the addition of part-time positions, in February the economy created 71,000 full-time jobs in February.  Average hourly earnings rose 5.0 percent from a month earlier, slightly lower than the prior month's 5.3 percent gain but still too high for the Bank of Canada's comfort. 

Despite the headline strength, there are plenty of reasons for concern over Canada's employment outlook.  The unemployment rate continues to edge higher, reaching 5.8 percent in February, while the employment rate has now fallen for five consecutive months, something not seen since 2009.  The culprit here is the continuing massive rise in the labour force as a result of unprecedented immigration rates. The working-age population rose by 83,400 in February alone and has risen by 1,030,000 or 3.2 percent in the last twelve months.  It is just about inconceivable that the economy could ever produce jobs sufficiently quickly to keep pace with this,

Even Canadians who are pro-immigration -- a cohort includes your esteemed blogger, himself an immigrant -- are not sure exactly how this is going to pan out.  The Federal government seems equally at a loss, announcing vague plans to reduce immigration after 2026.  We have just learned that the Federal budget will be tabled in mid-April, and it seems likely that Finance Minister Chrystia Freeland will cite the immigration data as part of a case for still more public spending. Bank of Canada Governor Tiff Macklem has hinted in recent months that lax fiscal policy is making the Bank's job harder. The rate cutting cycle is still largely expected to start in June, but could a big-spending budget push that back?  We will soon find out. 

The jobs keep coming

That darn struggling US economy just can't seem to stop creating jobs. Data this morning from the Bureau of Labor Statistics show that 353,000 new jobs were added in January, far ahead of expectations.  What's more, the initially-reported data for the two preceding months were revised higher by a total of 126,000. The unemployment rate held steady at 3.7 percent for the third month in a row. 

There can be no real doubt that Fed Chair Jay Powell had some advance knowledge of the data ahead of this week's FOMC meeting, so it is no surprise that he used his press conference to pour cold water on the notion that rate cuts could start as early as March. Looking beyond the headline figure, there is another element in today's release that serves to push rate cut expectations further into the future. Average hourly earnings rose sharply in January, up 0.6 from December, pushing the year-on-year increase to 4.5 percent from 4.1 percent previously.  This is clearly not compatible with the FOMC's wish to see inflation moving "sustainably" towards 2 percent before it contemplates rate cuts. 

Indeed, with the economy growing strongly and creating so many new jobs, why would the FOMC even consider risking an early rate cut, which could backfire by rekindling inflation expectations?  The economy clearly ain't broke, so there is little need to try to fix it. There are even signs that the US public is starting to take a somewhat less jaundiced view of the state of the economy, to which one can only say, what took you so long?

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.  

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. 

Almost there

Today brought an early Christmas gift for Fed Chair Jerome Powell and his FOMC colleagues. Data from the US Bureau of Economic Analysis showed that the personal consumption expenditure (PCE) deflator fell 0.1 percent in November, its first month-on-month decline since the depths of the COVID pandemic in April 2020. That lowered the year-on-year increase to 2.6 percent. The core PCE deflator, which is the measure the FOMC follows more closely, rose 0.1 percent in November, but that served to lower the year-on-year increase to 3.2 percent from the 3.4 percent recorded in October. 

The Fed's 2 percent target specifically aims at controlling the consumer price index, but these improvements in the PCE deflators appear to indicate that policy is on the right track. Is the Fed close to achieving the almost mythical soft landing for the US economy?  Maybe so.  Revised data released on Thursday by the BEA showed that real GDP rose at a 4.9 percent annualized rate in Q3.  That's a slightly lower figure than the Bureau previously estimated, but it shows the economy still maintains considerable momentum even as inflation drifts slowly toward the target rate. 

This week's data certainly make it clear that the Fed tightening cycle is at an end, but they do not necessarily tell us much about when an easing cycle might begin. Arguably, the fact that the real economy is still moving ahead allows the Fed the luxury of waiting a little longer to start that cycle, just to be completely sure that CPI inflation is heading all the way back to the target.  The next FOMC announcement is due on February 1.  That will surely not bring a rate cut, though it may allow the Fed to start offering hints about timing, as it is set to table a "Statement on Longer-Run goals and Monetary Policy Strategy" on that day. Actual rate cuts may follow in Q2 of 2024, in line with the "dot plot" from the last FOMC meeting, which pointed to a total of 75 basis points in cuts for 2024 as a whole.