Running hard but still falling behind

So, first the good news. According to Statistics Canada, the Canadian economy added 39,900 new jobs in August. That was about twice as large as the reliably risible analysts' consensus.  Fully 32,200 of the new jobs created in the month were full time. As a result of the large increase in employment, the unemployment rate was unchanged at 5.5 percent, after edging higher in each of the previous three months.

If only that were the whole story.  Thanks to rapidly rising immigration, the working age population rose by fully 103,000 in the month.  This meant that despite the strong job numbers, the employment rate, which measures the number of persons over age 15 actually working, fell by 0.1 percentage points, to stand at 61.9 percent. Note that the employment rate is not the same as the more frequently quoted participation rate, which includes the unemployed as well as the employed in the calculation. That ratio also slipped by 0.1 percentage points in the month, to stand at 65.5 percent. 

This is not just a one-month phenomenon. The working age population has grown by an average of 81,000 per month so far in 2023. Making allowance for normal dependency and participation patterns, the economy would need to create an average of 50,000 jobs per month to keep the unemployment rate unchanged.  The actual average monthly increase in employment so far this year has been 25,000. Note that these numbers come directly from the StatsCan media release -- they are not calculations done by me or some other analyst. 

This hardly seems like a sustainable pattern. There is evidence of serious pressure on housing markets across the country, with the three levels of government -- Federal, Provincial and municipal -- all pointing the finger of blame at each other. Canada has always had sickeningly high numbers of "rough sleepers" on city streets, but that sad phenomenon seems likely to be worse than ever just as the cooler weather starts to arrive.  Yet there are few signs within the Federal government, which ultimately controls overall immigration levels, that anything will be done to address the problem.

What does all this mean for Bank of Canada policy? A strong rise in employment is hardly a recipe for stable interest rates, let alone rate cuts. And yet, the massive rise in the working age population makes it possible to argue, as at least one major bank economist has already done today, that the tightness in the labour market may actually be easing despite the job gains.  This is a difficult argument to sustain unless you have evidence that the qualifications of the new arrivals match those needed in the labour force.  

Only time will tell if that is the case, though it should be added that large segments of the Canadian economy, from agriculture to medicine,  would collapse overnight but for the presence of immigrants. Muddling through without any sort of plan may work out just fine in the end, but the imbalance between population growth and employment in today's numbers suggests things could very quickly turn sour. 

On hold, but not happy about it

Mainly in response to last week's report of a decline in GDP during the second quarter of the year, markets had scaled back almost to zero their expectations for a further rate hike at today's Bank of Canada Governing Council meeting.  The Bank did indeed keep its overnight rate target unchanged at 5 percent, but the assertive tone of most of the press release gives the strong impression that but for that GDP report, today would have brought another rate hike. Consider these quotes: 

"....with measures of core inflation still elevated, major central banks remain focused on restoring price stability".

"Recent CPI data indicate that inflationary pressures remain broad-based..... CPI inflation is expected to be higher in the near term before easing again. Year-over-year and three-month measures of core inflation are now both running at about 3.5%, indicating there has been little recent downward momentum in underlying inflation. The longer high inflation persists, the greater the risk that elevated inflation becomes entrenched, making it more difficult to restore price stability"

Neither of those statements sounds like a central bank that thinks its work is done, but the latest developments in the real economy clearly made it impossible for the Bank to justify another rate hike at this time:

"The Canadian economy has entered a period of weaker growth, which is needed to relieve price pressures..... Economic growth slowed sharply in the second quarter of 2023, with output contracting by 0.2% at an annualized rate.......Final domestic demand grew by 1% in the second quarter, supported by government spending and a boost to business investment. The tightness in the labour market has continued to ease gradually. However, wage growth has remained around 4% to 5%".

Is there perhaps a hint of a suggestion there that the Bank wishes the Federal Government was not making its job harder by continuing to boost public spending?  Sure sounds like it, though the Bank is always careful not to make political statements, at least in public. Politicians, alas, feel no such constraint: the Premiers of both British Columbia and Ontario penned very public letters to Governor Tiff Macklem in recent days, urging the Bank not to hike rates further. And in the wake of the Bank's announcement, Federal Finance Minister Chrystia Freeland has issued a statement welcoming the news. These are not welcome developments and it's to be hoped they do not set some kind of precedent. 

The final paragraph of the press release deserves to be quoted in full:

"With recent evidence that excess demand in the economy is easing, and given the lagged effects of monetary policy, Governing Council decided to hold the policy interest rate at 5% and continue to normalize the Bank’s balance sheet. However, Governing Council remains concerned about the persistence of underlying inflationary pressures, and is prepared to increase the policy interest rate further if needed. Governing Council will continue to assess the dynamics of core inflation and the outlook for CPI inflation. In particular, we will be evaluating whether the evolution of excess demand, inflation expectations, wage growth and corporate pricing behavior are consistent with achieving the 2% inflation target. The Bank remains resolute in its commitment to restoring price stability for Canadians". 

Not to over-analyze that, but the fact that the "evidence" in the first sentence is described as "recent" rather than as, say, "growing" seems to underscore the importance of the GDP data in the Bank's decision today. The rest of the paragraph is just about as hawkish as anything the Bank has said over the past year and more; given that the Bank's definition of price stability continues to be the 2 percent target, it is clear that further rate hikes cannot be ruled out. Before the next rate setting date of October 25, we will see two more monthly sets of both employment and CPI data, as well as GDP data for August. It will take clear signs of weakness across that data set to take another rate hike off the table. 

The long-awaited recession??

So, is this the start of the long-awaited (and for the media, seemingly much-desired) recession in Canada? Statistics Canada reported this morning that real GDP fell at a 0.2 percent annualized rate in the second quarter of the year. It takes two quarters of declining GDP to meet the "official" definition of a recession, but weak monthly GDP data for June and July suggest that a further decline in Q3 is at least a possibility.

Before we look at the details, let's just pause to think about what a "0.2 percent annualized rate" looks like. StatsCan correctly states in its media release that "real gross domestic product (GDP) was nearly unchanged in the second quarter", not that the media will take any notice of that form of words.   If we "de-annualize" the number we find that it means real GDP in Q2 was 0.05 percent smaller than in Q1. That barely even qualifies as a rounding error, and it could well be eliminated (or, equally probably, revised to a larger decline) when updated estimates are available in a few months' time. 

Looking deeper into the data, we immediately see evidence that the Bank of Canada's aggressive rate hikes are having an impact on at least one segment of the economy. Housing investment fell 2.1 percent in the quarter; this was its fifth consecutive quarterly decline, which corresponds remarkably closely to the duration of the Bank's tightening moves. StatsCan calculates that this factor alone accounted for a 0.65 percent annualized rate of decline in real GDP, so aside from the decline in housing, real GDP would have risen at about a 0.4 percent annualized rate in the quarter.

It is worth spending an extra moment looking at the implications of this weakness in housing. Immigration levels into Canada are running at an unprecedented pace, led by surging numbers of foreign students, refugees and more conventional migrants. The country's population hit 40 million earlier this year and is set to grow by at least a million this year and next -- and there are suggestions that the numbers may in fact be undercounted. Unsurprisingly, this is putting great pressure on the housing market, as well as social services in general. The news that new housing construction plunged by 8.2 percent in Q2 could not have come at a worse time. 

Returning to the StatsCan data, we find a number of other contributors to slower growth. Business inventory accumulation slowed in the quarter, a development that may well be partly attributable to Bank of Canada policy, given the rising cost of carrying unsold goods. The trade sector was also a source of weakness, at least in a statistical sense, as growth in imports outpaced a very marginal rise in export volumes.

Growth in household spending was markedly lower in the quarter, posting a rise of only 0.1 percent after a gain of 1.2 percent in Q1. Interestingly, or perhaps ominously, per capita household spending fell 0.7 percent in the quarter, a development almost certainly linked to the large rise in population.  On a more positive note, real business investment rose 2.4 percent in the quarter after a prolonged bout of weakness. All in all, final domestic demand posted a rise of 0.3 percent in the quarter (about 1.2 percent annualized), a number that is in line with the previous quarter and that does not seem consistent with an imminent recession. 

As usual, StatsCan also posted new data on monthly GDP growth. Real GDP fell 0.2 percent in June, with both goods and services output falling.  Preliminary estimates show that real GDP was little changed in July, and it is this weak "handoff" from Q2 to Q3 that suggests overall weakness in growth could persist through the current quarter. That being said, it might be worth noting that the monthly data are particularly noisy at the moment. StatsCan notes that the severe forest fire season depressed output in a number of key sectors in June, and the prolonged port strikes in BC must also have had an impact. Experience suggests that the economy usually bounces back quickly from such events, but it may take some time for the impact on the monthly data to wear off.

Today's numbers represent the last major data point to emerge before the Bank of Canada's rate setting meeting on September 6.  Markets had been pricing in about a 25 percent chance of a further 25 basis point rate hike, but that now looks unlikely to happen.  Raising rates in the wake of a negative GDP report would be more than just a bad look for the Bank -- it would be bad policy.  

"Navigating by the stars under cloudy skies"

Who would have thought that Fed Chair Jerome Powell had so much poetry in him? Yet the title of this post is taken from the concluding paragraph of his speech today at the annual Jackson Hole economic policy shindig.  The rest of the speech is more prosaic, but offers some useful insights into how the Fed views its progress against inflation over the past eighteen months or so and what remains to be done. TL:DR version: recent developments are encouraging, but the job is not finished and rates will stay high for some considerable time.  Some highlights: 

The Fed mainly focuses on the personal consumption expenditure deflator to monitor inflation trends; this is a holdover from the Greenspan era. However, it remains committed to bringing the more familiar CPI down to the 2 percent target: "Two percent is and will remain our inflation target".  Given that the target is in fact up for renegotiation in 2025, and given musings in some quarters (hi there, Paul Krugman) that a slightly higher target might have some merit, this is a very strong statement of intent from Powell. 

Within the PCE measure, the Fed looks more closely at core PCE (i.e. excluding food and energy), and it breaks core PCE into three sub-components, for goods, housing services and non-housing services. 

• Core goods inflation has fallen sharply, which Powell attributed to unwinding of supply chain issues, along with tighter monetary conditions. Although core goods prices fell in the last two months, this measure remains well above its pre-COVID level. 
• Costs for housing services responded quickly to Fed tightening but it will still take some time for the full effects to be felt, because not all leases expire at the same time. The Fed expects this measure to settle near its pre-pandemic level. 
• Core non-housing services, accounting for more than half of core PCE,  may be the Fed's most intractable problem.  These prices were less subject to international supply issues during the pandemic but are generally labour-intensive, which presents a problem when the job market is so tight. 

Looking ahead, while continued unwinding of pandemic-related issues will be helpful, the Fed believes a period of below-trend economic growth will be needed to get inflation back to the target. Real interest rates have moved sharply higher over the past year, but the Fed is still "attentive to signs that the economy may not be cooling as expected", so that "additional evidence of persistently above-trend growth....could warrant further tightening of monetary policy".

The Fed is surprisingly relaxed about the state of the labour market. It sees rebalancing in that market as a contributor to easing pressure on nominal wages. Still, "Evidence that the tightness in the labor market is no longer easing could also call for a monetary policy response".

Powell ended his remarks by reminding his audience of the high level of uncertainty faced by policy makers, particularly as regards the lags with which monetary policy measures take effect. The Fed sees its current policy stance as restrictive, but -- paraphrasing here -- is it restrictive enough?  Having posed that question, Powell offered up his brief moment of poesy, before finishing with a blunt declaration: "We will keep at it until the job is done". 

We didn't start the fires

......but we can certainly manipulate the story for political advantage. Everybody's doing it!

Predictably, climate change activists are blaming the extremely active fire season in the Northern Hemisphere (Alberta!  BC!! Quebec!!! Yellowknife!!!! Hawaii!!!!! Tenerife!!!!!!) on climate change. Serious scientists are careful not to say climate change is the direct cause of these extreme weather events, but journalists are not so scrupulous. I actually heard one talking head this past weekend lumping the Ventura county earthquake in with Hurricane Hillary as a symptom of climate change.

On the other side of the spectrum, climate change deniers are taking equally extreme positions. A favourite argument is that the exceptionally high number of wildfires this year is mainly down to arson.  Every year there are fires that are directly caused by humans, either campers being careless with the matches or actual arsonists.  The added spice this year is that it is now apparently necessary to blame someone specific, and the bigger the culprit, the better the story.  Here in Canada I have seen it asserted, without a shred of evidence, that "climate vigilantes" have been setting fires on the direct orders of Justin Trudeau and/or the World Economic Forum. 

Let's just think about the logistics of this tsunami of arson for a second. The reason many of the fires in northern Quebec were allowed to just burn themselves out is that they happened in areas so remote that firefighters could not gain access to them. Yet we are apparently supposed to believe that arsonists were able to move freely about in these inaccessible regions, setting fire after fire and making it home safely to tell the tale. I don't think so. 

We may be able to exonerate Justin Trudeau from any direct involvement in setting the fires, but that doesn't mean he is not heavily involved in all this. His heart-on-sleeve "green" government is naturally playing up the role of climate change in all this (and completely downplaying any impact from arson).  But Trudeau is also seizing the opportunity to advance another part of his agenda: his battle to shake down Meta and Google to force them to bail out Canada's struggling legacy media, through an Act of Parliament known as Bill C-18.

Bill C-18 requires companies like Google and Meta to pay for any links they provide to Canadian news media. Meta has responded more robustly than Google, complying with the letter of the law -- though not its intent -- by removing such links from its websites.  The Government is furious, even though anyone with half a brain (and even some experts) tried hard to warn them this would happen.

Trudeau has glommed onto the opportunity provided by the forest fires, most notably those burning around Yellowknife, to lambast Meta for putting Canadians' lives at risk by depriving them of access to fast-breaking news.  Two points here: first, my own very informal and unscientific survey suggests that virtually no-one actually relied on Meta platforms for access to news sources.  Second, Trudeau has  apparently not found it necessary to suggest to the media that they might remove their own paywalls for the duration of the crisis. So even if you still had access to, say, the Toronto Star via Facebook, you still wouldn't be able to read anything beyond the headline: the paywall would keep the actual content from you. Well thought through there, Justin. 

Canada July CPI: the sky is falling!

Spoiler alert: no, it isn't.  The headline number in the data released by Statistics Canada today is certainly surprising, but a peek into the details of the data suggests that the underlying downward trend in consumer inflation remains intact. 

The headline number, and the only one the media can be bothered to look at, was assuredly way worse than expected. Year-on-year headline CPI rose 3.3 percent in July, up from 2.8 percent in June. On a month-to-month basis headline CPI rose 0.6 percent (unadjusted), compared to a consensus expectation of 0.3 percent.

There are a lot of moving parts behind that number -- so many, in fact, that the StatsCan press release manages to be quite confusing. For example, within the first few paragraphs we read first that Acceleration in headline consumer inflation was mainly attributable to a base-year effect in gasoline prices and then that The mortgage interest cost index (+30.6%) posted another record year-over-year gain and remained the largest contributor to headline inflation.  Both statements are factually accurate, but they could undoubtedly have been better expressed or at least less closely juxtaposed. 

As the first of those two quotes may suggest, the famous "base effect" continues to bedevil the statistics. For the past year your blogger and others have been cautioning that the steady decline in headline year-on-year CPI owed a lot to big monthly inflation numbers from early 2022 falling out of the index. That process is at an end, making further progress toward the Bank of Canada's 2 percent target more difficult. Specific to the July data, StatsCan is pointing out that in July 2022 gasoline prices fell 9.2 percent, whereas in June this year they edged up 0.9 percent. That creates a very powerful base effect that biases the whole index higher.

As for the mortgage cost index, all that can really be said (again) is that Bank of Canada rate hikes are a major contributor to the above-target headline CPI.  Excluding mortgage costs, the year-on-year rise in CPI for July was 2.4 percent, within hailing distance of the Bank's target.  One interesting aside: "CPI excluding mortgage costs" is not one of the regular raft of "special aggregates" that StatsCan tabulates each month, which suggests that nobody at the agency ever expected the current situation to arise.

Speaking of special aggregates, the Bank of Canada's three favoured measures of core inflation continue to head in the right direction. The mean level of those measures edged down by 0.1 percentage points in the month and now stands at almost exactly 4 percent. 

What does this mean for the Bank of Canada's next rate decision in early September? The Financial Post headlined its report on today's data this way: "Hotter-than-expected inflation turns up heat on Bank of Canada".  But does it really?  If the Bank were to hike rates on the basis of today's headline number, it would in effect be reacting to the fact that gasoline prices fell sharply in July 2022, because that's what caused the jump in headline CPI we witnessed today. That doesn't seem very likely. 

US CPI for July: nothing much to see here

Data released by the BLS this morning show that US headline CPI rose 3.2 percent year-on-year in July, up from a 3.0 percent increase in June. This marked the first time the headline index has ticked up since this time last year, but the data do not represent any change in the underlying downward trend in inflation. Rather, the number serves to underline the fact that the so-called base effect is now played out. The outsized monthly CPI increases seen in late 2021 and early 2022 are now fully out of the yearly index, which now more accurately reflects the current inflation picture.

On a month-to-month basis, headline CPI rose 0.2 percent in July, the same pace as in June. The sub-index for shelter costs accounted for fully 90 percent of the monthly increase; that sub-index is, of course, heavily influenced by the Fed's rate hikes. Core CPI, excluding food and energy, rose 4.7 percent in July from a year earlier,  still well above the Fed's 2 percent target.  However, the monthly increase in this measure was 0.2 percent, the same as in June. The annualized rate of growth in both headline and core CPI thus seems to be running only slightly above the target rate.

All in all, today's data should give the Fed room to keep rate on hold at the September FOMC meeting, and it is quite conceivable that the current tightening cycle has reached its peak. Talk of rate cuts is certainly premature, but it is likely that year-on-year CPI will consistently have a 2-"handle" by the end of this year. 

UPDATE, August 11: Producer price index (PPI) data released today by the BLS are slightly less encouraging than the CPI data. PPI rose a higher-than-expected 0.3 percent in July, the biggest monthly gain since the start of 2023. Still, the year-on-year increase is well below the rise in CPI -- and the Fed's inflation target -- at 0.8 percent.  The most concerning aspect of the report for Fed policymakers is likely to be the fact that prices for services rose 0.5 percent in the month, as opposed to a rise of only 0.1 percent in goods prices. It is difficult to blame higher service prices on international supply shocks.