Canada jobs market remains strong

StatsCan reported this morning that the Canadian economy added 11,000 jobs in July, the eight consecutive monthly gain. Although the headline was merely in line with the consensus expectation, rather than blowing past it as has been the case for most of this year, the details of the report confirm that the jobs market remained strong at the start of the third quarter of the year.

• Full-time employment rose by 35,000 in the month, offset by a 24,000 decline in part-time employment.  Taking these two numbers together, there was a healthy 0.6 percent rise in hours worked in the month, for a year-over-year increase of 1.9 percent.

• A total of 387,000 jobs has been created in the past twelve months, the highest figure in a decade.  The overwhelming majority of these jobs -- 354,000 -- have been full-time positions.

• The unemployment rate fell by 0.2 percentage points to a nine-year low of 6.3 percent.  This partly reflected a small decline in labour force participation, although the participation rate for the core age group (i.e. excluding the youngest and oldest) was unchanged. 

• Average hourly wages remain tame, with 1.3 percent year-on-year growth recorded in each of the past three months, barely keeping up with inflation.

The persistent strength in the labour force data over the past year or so has taken some of the focus away from the volatility in the numbers, which used to make it difficult to perceive the underlying state of the jobs market.  For what it's worth, the data on self-employment still seem somewhat erratic, albeit less so than in the past, but for the moment there can be no dispute that the employment situation in Canada is the strongest it has been since the onset of the financial crisis.  

There can be little doubt that Q2 GDP data, due for release on August 31, will be strong, and today's data indicate that the strength has persisted into the current quarter.  This means that the economy is likely to reach effective full capacity by the end of this year, in line with the Bank of Canada's forecast.  Although the persistently low growth in wages will give Governor Poloz and his colleagues something to think about, it is very likely that the Bank will implement another 25 basis point rate increase at its October Governing Council meeting, when it will also release its updated economic outlook.  

This is getting serious

Another month, another decline in Toronto-area house prices.  The Toronto Real Estate Board (TREB) reported today that home prices in the region fell 6 percent in July.  That's the third straight monthly decline since the Ontario Government introduced a package of measures aimed at reining in the market.  It's all but impossible these days to find anything attempted by the provincial government that goes according to plan, but this surely has.

TREB is trying to put on a brave face.  It notes three factors that, at least in its view, mitigate the pain.  First, prices are still higher year on year, by about 5 percent.  This is true, but it won't stay true for long if the month-on-month declines continue.  Second, it argues that the summer season is usually quiet, with activity often picking up after Labour Day.  That's not much of a mitigation, given that a year-on-year price comparison is by definition measuring the change between comparable periods (i.e., presumably the market was quiet last July also).  Third, it notes that a similar sharp pullback was seen in Vancouver last year, when the provincial government there also imposed market cooling measures.  That market has now begun to see prices rises again, albeit at a modest pace.

Is that Vancouver experience likely to be repeated in Toronto?  The very sharp decline in sales (down a remarkable 40 percent from July 2016) and the rise in listings (up 5 percent) seems to suggest that the entire direction of the Toronto market has changed.  There must be very few potential buyers out there right now who don't think they can afford to wait a little longer in hopes of getting an even better deal.  Moreover, the fact that the Bank of Canada has started to raise interest rates, together with the prospect of tighter regulation of the mortgage market in the coming months, also argues against a sharp rebound.

Recent reports estimate that there are close to 50,000 registered realtors in the Toronto area, although many of them seem to pursue it as a side gig, doing few if any deals.  Despite the number of chancers who have jumped into the "profession" in recent years, real estate fees remain at sky-high levels, close to 5 percent.  Realtors directly contributed to the price spiral seen in recent years, encouraging bidding wars at every turn in order to boost their own incomes*.  Despite their stoical public posture, TREB and its members must be starting to feel very queasy indeed.  It's hard to feel sorry for them.

* As this article reports, fees associated with home sales now account for almost 2 percent of Canada's GDP.     

Rush to judgement

Well, that didn't take long.  Barely two weeks after the Bank of Canada ended five years of ultra-low interest rates by venturing a 25 basis point increase in its target rate,  anonymous officials in Ottawa are apparently fretting via Bloomberg that the Bank's actions could trigger a slowdown in the economy.

Can this possibly be a reasonable fear?  After all, the Bank's new target rate is only 0.75 per cent, and even if it follows through with another rate hike this year, as seems likely, that would still leave the rate negative in real terms -- and way below levels that were considered normal and manageable before the financial crisis hit.  Most business economists interviewed by the media have dismissed the concerns of the unnamed bureaucrats, preferring to believe that the economy is in good shape to withstand not just another rate hike this fall, but also a couple more small upward moves during 2018.

I'm with the business economists on this one, but the truth is, nobody really knows, because we've never been here before.  Ultra low interest rates and large-scale printing of money have never been tried before by any responsible central bank.  Nobody envisaged that the QE-plus-free-money era would last the better part of a decade, engendering a belief on the part of many people that borrowing was essentially free and riskless.  The elevated level of household debt in Canada is apparently a key factor underlying the concerns in Ottawa.

Thoughtful commentators warned years ago that stopping monetary stimulus would be a lot harder than starting it. The caution being shown by the Federal Reserve in raising rates and tapering QE clearly shows that central bankers are aware that they are flying without a compass here. Despite his more hawkish rhetoric in advance of the recent rate hike, it's apparent that Bank of Canada Governor Stephen Poloz is also minded to proceed with extreme caution, ready to reverse course if the economy reacts badly to gradual policy tightening.

As it happens, economic data released today clearly show why the Bank saw the need to start raising rates this month.  Canada's GDP rose 0.6 per cent in May, far ahead of expectations.  It now stands 4.6 percent above its year-earlier level, the strongest such gain since 2000.  The Bank's expectation that the economy will reach effective full-capacity by the end of this year seems certain to be met. The strength in the exchange rate -- up 10 percent in the last two months -- will have to factor into the Bank's thinking at some point, but there is no reason to second-guess the recent change in its policy stance.  

How soon is now?

Just about nobody had been expecting the Fed to raise the funds target again today.  Thus, the only real point of interest in today's FOMC press release was the timing of the previously-announced plan to start unwinding QE (or balance sheet normalization, as the Fed prefers to call it). Would the Fed announce a timetable?

No, it would not.  The press release simply stated that the FOMC "expects to begin implementing its balance sheet normalization program relatively soon". Exact timing, as with the further rate hikes that are surely coming, depends on the data flow.

It's hard to blame the Fed for keeping its cards close to its collective chest.  No central bank has ever tried anything like QE before; the experiment has almost certainly run for much longer than the FOMC expected when it launched it; and there is no playbook for unwinding it.  Ending QE will not be like pulling off a bandage,  where the faster you do it, the less it hurts.  Getting this wrong could be way more damaging than tightening rates a little too fast.  All the same, a touch more clarity from the Fed today might have been helpful, if only to avoid the impression that it doesn't quite know how to proceed.  

EU-phemism du jour

The dire warnings from the UK business sector about the consequences of a hard Brexit seem to be sinking in. UK Trade Secretary Liam Fox now says that it would be nice to have a transititional phase between the date certain that the UK leaves the EU (in March 2019) and the full severing of the UK's trading relationships with the Eurozone.  In the usual UK style, Fox seems to imagine that the UK can not only impose such a transitional period on the EU, but also decree how long it should be.

After a month of shambolic "negotiations" on the UK side, the Europeans are starting to lose patience.  Consider this quote from German auto boss Matthias Wittmann: "You need a transition period.  We hope that on the British side that gets deeper and deeper into the intellectual capabilities of those who decide".

That's a charming way of putting it, possibly even nicer in German. What Herr Wittmann really means is "we hope the British can get this into their thick skulls".  One can only say, if that's what Herr Wittmann hopes, he plainly hasn't spent much time with Liam Fox, or with his equally arrogant but incompetent colleagues, David Davis and Boris Johnson.

Donald Trump's NAFTA wishlist

A promise to rip up or at least renegotiate the North American Free Trade Agreement, "the worst trade deal in history", was a key part of Donald Trump's election platform.  Six months after Trump's inauguration, his administration has now published a comprehensive list of what it hopes to get out of the renegotiation, which is supposed to begin around August 17.  There are some important demands that will cause serious problems for Ottawa's negotiators, but the list also includes a number of items that would be widely welcomed by Canadian consumers.

Let's start with the problematic stuff:

• The US wants to eliminate entirely the dispute resolution mechanism in the current NAFTA agreement, known as Chapter 19.  In a way this is a bit surprising: the US always seems to ignore judgments made against it under this chapter.  Removing it is likely to be something of a red line for Canadian negotiators, particularly since the US recently imposed fresh tariffs against Canadian softwood lumber, and Chapter 19 would currently be the mechanism for attempting to resolve this issue,  It is difficult to see how a free trade agreement can exist without some provision for handling disputes, but that will be the US position going in.

• Free trade agreements these days are as much about investment as trade in goods, and the US is seeking greater rights for US companies to make investments in Canadian or Mexican companies.  Canada severely restricts or outright prohibits foreign ownership in a number of key sectors of the economy (banking; media; airlines) and this may well turn out to be an area of serious disagreement.

• The US appears to want asymmetrical rules on public contracts.  While it wants US companies to have unfettered access to tenders in Canada and Mexico,  it seeks to maintain its Buy America provisions (particularly close to President Trump's heart) and to exempt state and local government procurement altogether.  Canada unashamedly favours domestic producers for large public contracts, often with disastrous results, as the fiasco of Toronto's streetcar deal with Bombardier shows.  The problem at the negotiating table is likely to be the fact that many of these preferential deals originate at the provincial rather than national level; it will be difficult for federal negotiators to water them down.

Then there are the provisions that are likely to go down well with Canadian consumers:

• Although dairy products are not mentioned specifically in the US wishlist, Canada's extraordinary supply management system has been a bone of contention for many years.  It represents one of the most egregious examples of "producer capture" to be found anywhere in the world.  Production of milk, butter, cheese and eggs is subject to strict quotas and import restrictions, which keep the farmers profitable but mean that Canadian shoppers pay far more than their American neighbours for these staple food items.  It's hard to imagine that many Canadians (aside from the influential farm lobby) would be sad to see the whole system blown up.

• Canadians face some of the world's most miserly limits on cross-border duty free purchases, with anything above C$ 20 subject to duty.  The US wants that limit raised to C$ 800.  This would bring joy to the legions of Canadians who line up at the border crossings here in Niagara each day on their way to American malls, but would deal a further severe blow to the ailing retail economy of the region. 

What's most striking about the US list, at least from a Canadian perspective, may be the fact that it has been published at all.  That has happened thanks to the more open US system of governance.  The Ottawa government no doubt has a similar wishlist of its own, but is under no obligation to publish it. Canadians will only find out what their government is prepared to deal away once the talks get started.
 

One small step for the Bank of Canada

The Bank of Canada raised its overnight rate target by 25 basis points to 0.75 percent today, in line with the very heavy hints dropped by Governor Stephen Poloz over the past few weeks.  This was the first upward move in rates in seven years. The press release issued by the Bank was considerably longer and more detailed than usual. Surprisingly, however, neither the release nor Poloz's opening statement to the media   made any mention of what many would consider to be the elephant in the room: the state of the housing market, especially in the Toronto area.

We'll come back to housing later, but let's focus first on the Bank's justifications for today's move.  Poloz has extolled the strength of the Canadian economy in recent weeks as he has softened up the markets for a rate move.  The Bank does not expect the 3.5 percent GDP growth rate seen in Q1 of this year to persist; it sees growth for 2017 as a whole at 2.8 percent, slipping to 2 percent in 2018 and 1.6 percent in 2019.  However, it expects the output gap in the economy to disappear by the end of 2017, considerably sooner than previously forecast.  Moreover, since the Bank sees the economy's potential growth rate as no more than about 1.5 percent, even the modest growth projected for the out-years of the forecast will trigger capacity constraints, and hence generate inflationary risks.

The imminent absorption of excess capacity in the economy is the driving factor behind today's action, but the Bank readily acknowledges that it is slightly incongruous to launch a tightening cycle while inflation is well below its 2 percent target.  Both headline CPI and the trio of core measures used by the Bank have seen inflation stuck near 1.5 percent in the last several months.  The Bank clearly believes this is driven by temporary factors, such as the electricity rebates being offered in Ontario by the increasingly desperate Wynne government. As these temporary factors wane and capacity use tightens, the Bank looks for CPI to move up to its target in 2018, with a slight overshoot of the target in 2019.  

So, what about the housing market?  All of the recent data confirm that the Toronto-area market, which was spiralling higher just three months ago, has hit a wall.  Prices have fallen sharply, listings are up and the number of transactions is down.  Ever since Governor Poloz started talking tough, personal finance experts in the media have been ramping up their warnings about how stretched some households' finances are, and urging those on floating rate mortgages to consider locking in a fixed rate.  Gov. Poloz's rate hike hints have of course been reflected in the bond market, so fixed mortgage rates have risen even ahead of the Bank's actual move.  

Given the possibility that higher rates could trigger problems for household finances, why has the Bank chosen to raise rates anyway?  The obvious answer is that the Bank has to run its policy in the interests of the entire country; it cannot allow monetary policy to be dictated by the actions of panicky homebuyers in just one market, even one as dominant on the national stage as Toronto's undoubtedly is.  Moreover, the Bank can clearly see that the long-awaited correction in the Toronto market is fully underway, rate hikes or no: the calming measures introduced by the Province of Ontario in April have had a much more rapid and profound effect than even the government itself can have expected.  

Despite the lack of focus on it in the Bank's statements today, there can be no doubt that the reaction of the housing market will play a major part in the Bank's thinking as it ponders its next move.  Gov. Poloz described the Bank's stance this way:

Governing Council acknowledges that the economy may be more sensitive to higher interest rates than in the past, given the accumulation of household debt. We will need to gauge carefully the effects of higher interest rates on the economy.

Future adjustments to the target for the overnight rate will be guided by incoming data as they inform the Bank’s inflation outlook, keeping in mind continued uncertainty and financial system vulnerabilities.

Data-dependent, then, as always.  Markets appear to be looking for one more 25 bp hike this year, with a further 50 bp to follow in 2018.  That looks about right, and would still leave rates well below historically normal levels.