Strong jobs data -- not helpful!

So a month ago, Statistics Canada announced that the economy shed more than 2,000 jobs in March, with the unemployment rate jumping to 6.1 percent.  In the minds of both analysts and the media, this seemed to lock in the case for a rate cut by the Bank of Canada on June 5; more recent announcements from the US -- slowing employment growth, rising initial jobless claims -- appeared to suggest that a rate-cutting cycle might soon be underway south of the border too.

That consensus has been put into doubt by Canada's April employment data, released this morning by Statistics Canada. Employment rose a staggering 90,000 in the month, way above all expectations. Despite that increase, the unemployment rate was unchanged at 6.1 percent as the labour force continued its torrid growth, rising more than 107,000 from the preceding month. Even allowing for the customary extreme volatility of Canada's employment data, the headline numbers certainly cast doubt on the likelihood of an early rate cut.

Media coverage of the data has quickly focused on the fact that 50,000 of the new jobs were part-time in nature. True enough, but this may be something of an aberration: for the past year as a whole, full-time employment has risen by 272,000, compared to only 104,000 new part-time positions.  The standard critique, that it is only the public sector that is creating jobs, also does not apply, as 50,000 of April's new jobs were in the private sector, with a further 14,000 representing self-employment. 

One welcome development from a policy standpoint is that wage growth slowed in the month. Average hourly earnings rose 4.7 percent year-on-year, down from the 5.1 percent gain recorded in March. However, given Canada's lamentable productivity record, that still seems too high for the Bank of Canada's comfort.

Expectations for a June rate cut, and the relief it will bring for mortgage borrowers, have been firmly locked in for some time now, and the Bank will be wary of crossing up the markets.  However, it appears that the April CPI data, due for release on May 21, may now be the crucial factor in determining whether that early rate cut happens. Recall that headline CPI ticked up to 2.9 percent year-on-year in March, with unexpectedly strong month-on-month gains. Another negative surprise in the April data could well push the start of the rate-cutting cycle back to the following Governing Council meeting, set for July 24. 

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. 

Accelerating into a recession?

I'm almost embarrassed to be criticizing media coverage of the Canadian economy again, but the denizens of the newsrooms leave me very little choice. This morning Statistics Canada reported that real GDP grew 0.2 percent in February, compared to a downward-revised increase of 0.5 percent in January. The preliminary estimate for March is that real GDP was almost unchanged in the month.  Markets immediately interpreted the data as clearing the way for the Bank of Canada to deliver a rate cut at its next Council meeting on June 5.  That's probably still the correct call, but the picture is not quite as simple as the headline numbers (and the media) make it look. 

StatsCan estimates that real GDP growth for Q1 as a whole will probably come in at 0.6 percent quarter-over-quarter, or an annualized rate of about 2.5 percent. That's significantly stronger than the anemic 0.2 percent quarter-over-quarter growth rate reported for the final quarter of 2023.  It's also pretty much in line with most estimates of the economy's long-term potential growth rate. That suggests that if the economy is moving into a situation of excess supply, which would be disinflationary, it's doing so at a glacial pace. 

The slowdown in monthly growth from January to February and seemingly again from February to March may be significant, but it needs to be interpreted carefully.  The strong number posted for January was heavily influenced by the end of public sector strikes in Quebec.  The underlying pace of growth in the economy is probably somewhere between the February and March numbers, hardly a robust showing but not one that points unequivocally to an imminent recession. The February report would in fact have been higher but for a pullback in utilities output in the month, reflecting the unusually mild winter weather across most of the country this year.

Where does this report leave the policymakers at the Bank of Canada? The estimated quarterly figure is more or less in line with the Bank's most recent forecasts, and it is important to recall that the Bank expects GDP growth to accelerate as the year progresses. The latest inflation data showed an unwelcome uptick, which the Bank will not want to see repeated when the April figures are reported in mid-May. Lastly, there is increasing speculation that the Federal Reserve will not start reducing rates until September or even December, and the Bank will not want to untether Canadian rates too completely from those in the US, for fear of causing the exchange rate to weaken sharply. 

In short, it's still not an easy choice. Barring a very nasty inflation surprise, a 25 basis point rate cut in early June is still the likeliest outcome, but it now seems unlikely that the Bank will be able to follow up with further cuts at each of its meetings in the second half of the year.  

  

Canada's Federal budget: anchors aweigh

Justin Trudeau became Prime Minister of Canada in October 2015 partly on a promise to run small fiscal deficits for just a few years in order to boost the economy.  There was always supposed to be a plan to move the budget back into balance, and in the meantime the debt/GDP ratio would serve as a backstop fiscal anchor to keep deficits and debt from getting out of hand. It became clear quite quickly that the deficits would be bigger and more persistent than Trudeau had intimated -- and then came the COVID crisis, to which the government quite correctly responded by hugely boosting spending and the deficit. 

As the threat from COVID eased, the budget deficit began to fall quite rapidly, but in the last couple of years Trudeau and his Finance Minister Chrystia Freeland have made it clear that they have no intention of reining in the government's finances. The 2024 Federal budget, unveiled by Freeland on Wednesday, indicates that all of the fiscal checks and balances promised back in 2015 have been abandoned.

You can read a summary of the government's proposals here. As promised in Trudeau's pre-budget cross-Canada tour, there is heavy emphasis on measures to boost housing availability and affordability  -- in effect, attempting to solve problems that have in large measure been created by the government's own out of control immigration policies.  There are a few revenue-raising measures, of which the most significant is a boost in capital gains taxes. This is supposed to raise something like C$ 20 billion, even though it is targeted only at the wealthiest 0.13 percent (really!) of taxpayers.

The end result of this is a string of deficits stretching out over the usual five-year planning horizon. The deficit for the just completed fiscal year 2023/24 was C$ 40.0 billion. It is projected to be remarkably sticky this year and next, at C$ 39.8 billion in FY 2024/25 and C$ 38.9 billion in FY 2025/26.  After that, the deficit magically starts to fall much faster, but even by the end of the planning period, FY 2028/29, it is still projected to be C$ 20.0 billion. Every single one of these numbers is higher than was projected in the Fall Economic Statement back in November. And the fact that the deficits seem to fall faster in the "out years" is of course completely bogus, with an election due by October 2025 at the latest. We seem to be back to the kind of budgetary forecasting that got Canada into a fiscal mess under Tory governments back in the 1990s.

There is nothing wrong with deficit financing in principle. The idea that deficits always cause inflation is wrong; so is the idea that government financing needs "crowd out" private sector borrowers. And anyone who followed the ill-fated austerity approach followed by the UK government after the global financial crisis surely knows that you can never correct a budget deficit by squeezing the economy. The only true constraint on the economy is the availability of real resources, be they labour, capital goods or raw materials. As Keynes famously put it, "anything we can do, we can afford".

That's precisely the issue here. The Bank of Canada has had to keep interest rates uncomfortably high for a long time because the economy has been running very close to full capacity, or full resource utilization if you prefer. Bank Governor Tiff Macklem has subtly suggested more than once that high  government spending has made the task of reducing inflation much harder than it needed to be. 

It's arguable that the recent uptick in the unemployment rate has eased some of those concerns, something the Bank has acknowledged in its policy pronouncements.  However, it is not clear that the pool of available workers, which largely consists of new arrivals and job-seeking college graduates, matches the current needs of the economy. To take just one example, the budget's commitment to build over 3 million homes by 2031 is going to require an awful lot of skilled construction workers. It is not at all clear where those people will be found. 

Announcing its most recent monetary policy decision, the Bank of Canada projected that the economy would start to move out of its recent mini-slump after mid-year. As a result, the small amount of excess supply that has emerged over the past several months will quickly be eliminated, which would serve to put a floor under just how low the Bank can lower interest rates without reviving inflationary pressures. This Federal budget, which has been roundly condemned by such worthies as former Finance Minister Bill Morneau and former Bank of Canada Governor David Dodge, looks certain to continue to make the Bank's job more difficult in the coming years.

What a choice Canadians face when the election finally rolls around. The abrasive Tory leader Pierre Poilievre and his seriously inexperienced team, or the experienced but reckless Trudeau/Freeland combo. Polls say the election is Poilievre's to lose, and there does not seem to be much in the budget to change that. 

Canada CPI: could have been worse

The sharp snap-back in US CPI for March that was reported last week led to concerns that Canada might see a similar unwelcome development when its own data were released. Today Statistics Canada reported that inflation did indeed tick higher in March, but much less sharply than in the US. Headline CPI rose 2.9 percent from a year ago, up from the 2.8 percent recorded in February, thus staying just below the upper limit of the Bank of Canada's target range.   

The data have led to a sigh of relief in financial markets, on the basis that a rate cut in June remains "within the realm of possibility", as Bank of Canada Governor Tiff Macklem put it last week. But before we look at the details of today's report, it is worth noting that the month-to-month changes tell a less hopeful story than the year-on-year figures do.  Before seasonal adjustment, CPI rose 0.6 percent from February to March, while the seasonally adjusted index rose 0.3 percent. If the Bank is looking for evidence that the deceleration in CPI is being sustained, these numbers do not provide it. 

In terms of the main contributors to the rise in CPI, we are yet again looking at the usual suspects: shelter costs and gasoline prices. Shelter costs are up 6.5 percent from a year ago, with rents 8.5 percent higher and mortgage interest costs up 25.4 percent. That last number is within the direct ambit of the Bank of Canada, but the overall increase in shelter costs is also heavily influenced by the very rapid, largely immigration-driven increase in Canada's population. 

Gasoline prices rose 4.5 percent in March, mainly in response to international developments, to stand 4.9 percent higher than a year ago. With international tensions ratcheting yet higher, gas prices are set to boost headline CPI again in April. On top of that there is also the increase in the Federal carbon tax, which took effect on April 1, to be reckoned with, though it is noticeable at least in my local area that that increase does not seem to have had much impact on prices at the pumps.

Turning to the widely-followed special aggregates, we find that almost all core measures -- ex food, ex energy, ex gasoline, ex food and energy -- have all slipped just below 3 percent. Goods prices are up just 1.1 percent from a year ago, but services prices have risen 4.5 percent, which will be a concern for the Bank of Canada.  The Bank's own preferred gauges of core inflation all edged lower in March, with their mean level now standing just below 3 percent. These numbers all seem to support the notion that a rate cut could some as soon as June 5. 

With the inflation numbers out of the way, attention now turns to the Federal budget, set to be tabled later this afternoon. We await this with less than bated breath, since PM Trudeau has spent the last several weeks gallivanting about the country making extravagant spending promises, mostly relating to housing. The only surprise left for Finance Minister Freeland to unveil is whether she will be raising taxes in order to avoid ballooning the deficit. (Spoiler alert: probably).

The Bank of Canada will be watching the budget closely, of course.  Governor Macklem has hinted several times that public spending is serving to boost the economy, which obviously makes it harder for the Bank to get inflation down and start cutting interest rates. With the government clearly gearing up for an election, Macklem's message seems likely to fall on deaf ears.

Bank of Canada: we're getting there

As expected, the Bank of Canada kept its overnight rate target unchanged at 5.0 percent today. The media release was rather longer than usual, reflecting the fact that the Bank also issued an updated Monetary Policy Report. Based on the media release and Governor Macklem's subsequent comments, most analysts believe that a rate cut in June is still probable, but the latest inflation developments in the US may yet delay things. 

Key quotes from the media release include:

• The Bank has revised up its forecast for global GDP growth to 2¾% in 2024 and about 3% in 2025 and 2026. Inflation continues to slow across most advanced economies, although progress will likely be bumpy. Inflation rates are projected to reach central bank targets in 2025. 
• In Canada, economic growth stalled in the second half of last year and the economy moved into excess supply.....the unemployment rate has risen gradually, reaching 6.1% in March. There are some recent signs that wage pressures are moderating.
• Economic growth is forecast to pick up in 2024. This largely reflects both strong population growth and a recovery in spending by households.......Overall, the Bank forecasts GDP growth of 1.5% in 2024, 2.2% in 2025, and 1.9% in 2026. The strengthening economy will gradually absorb excess supply through 2025 and into 2026.
• CPI inflation slowed to 2.8% in February.....However, shelter price inflation is still very elevated, driven by growth in rent and mortgage interest costs. Core measures of inflation....slowed to just over 3% in February, and 3-month annualized rates are suggesting downward momentum. The Bank expects CPI inflation to be close to 3% during the first half of this year, move below 2½% in the second half, and reach the 2% inflation target in 2025.

All in all, this sounds very much like the soft landing that the Bank and its peers around the world have been striving to achieve.  Even so, the Bank is not quite ready to commit to a rate-cutting cycle just yet. As the media release puts it, and as Governor Macklem repeated in his comments after the rate announcement, "While inflation is still too high and risks remain, CPI and core inflation have eased further in recent months. The Council will be looking for evidence that this downward momentum is sustained".  Analysts' interpretation of this is generally that the Bank just needs to see "more of the same" before it starts cutting rates. It will have two more months of CPI and employment data to hand by the next rate announcement date on June 5, and that data will be crucial to its decision.

The importance of ensuring that progress against inflation is "sustained" is underscored by the US CPI data for March, released just ahead of the Bank of Canada's announcement this morning. Headline CPI jumped to 3.5 percent year-on-year from February's 3.2 percent reading, driven by shelter and gasoline costs, while core CPI stands at 3.8 percent year-on-year.  The data drove US markets sharply lower and led many analysts to all but rule out any possibility of a Fed rate cut in June.

There is no direct link between US and Canadian inflation, but gasoline and shelter costs are a big part of the index in both countries. A similar nasty shock in Canada's CPI in the next month or two, most likely due to gasoline prices, cannot be ruled out.  There is no doubt that the Bank of Canada would like to get started on an easing cycle, with the Canadian economy notably underperforming the US in recent months, but the data could yet derail expectations for a June rate cut. 

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.