Canada GDP clears the way for a rate cut

Canada's GDP data for Q1/2024 appear to leave the way open for the Bank of Canada to deliver a rate cut on June 5. According to Statistics Canada, real GDP grew at a 1.7 percent annualized rate in the quarter, marginally below analyst expectations. Growth for the final quarter of 2023, initially reported as a small  gain, was revised downward to flat.

Details of the report suggest that key segments of the economy continue to show solid growth. Most notably, household spending grew 0.8 percent in the quarter, or over 3 percent at an annualized rate, led by spending on services. This allowed per capita household spending to eke out a 0.1 percent gain, after three quarters of decline. The household savings rate of 7.0 percent was the highest since Q2/2022, suggesting that households will be able to maintain expenditure levels in the near term.

Business capital spending and residential investment also posted gains in the quarter. The main factor that served to keep overall GDP below expectations was a significant slowdown in inventory accumulation. This is generally a volatile component of the report and it is unlikely to represent the start of a new trend.

Alongside the quarterly data, StatsCan also reported monthly GDP figures for March.monthly GDP figures for March. GDP was flat in the month after rising 0.2 percent in February. Of the 20 sectors tracked by StatsCan, 11 posted higher output in the month, with notable gains in construction and the public sector. However, manufacturing output fell 0.8 per cent, mainly as a result of retooling shutdowns. Preliminary data for April suggest GDP grew by 0.3 percent in the month, with broad-based gains.

Today's report is the last major piece of data that the Bank of Canada will see before next week's rate decision, although it is possible the Bank will get a sneak peek at May employment data, which are due for release on June 7.  A 25 basis point rate cut next week may still be a close call, but seems the most probable outcome. However, the Bank will likely stress that it will maintain a cautious approach in the months ahead, with a total of 75 basis points of easing by the end of this year.

It's not the economy, stupid

Back when Bill Clinton was running for re-election as President, he famously had a big sign on his desk that read "it's the economy, stupid". It was there to remind him and his campaign team that pocketbook issues were all-important to the electorate.

Clinton's mantra doesn't seem to hold up any more. There are elections coming fairly soon in three countries that I follow quite closely: the UK in July, the US in November, and Canada on a date yet to be announced, but likely some time in the next twelve months.  The incumbents in all three countries seem very likely to be defeated, even though their economies seem to be doing tolerably well.

Consider. In the UK, the economy has finally emerged from recession and may actually be growing faster than near neighbours such as Germany. Inflation has dropped sharply. It's true that the economy is smaller than it would have been in the absence of Brexit, but given the short memories of most voters, that ought not to count for much any more. In the US, a remarkably high percentage of voters believe the economy is in recession, which is very far from the truth. Inflation is well down from its cyclical peak, though it is starting to look a bit sticky, and unemployment is very low. The fiscal situation is a mess, but when did voters ever care about that? And in Canada, despite the negative tone of much media coverage over the past year, the economy has stayed out of recession. Inflation has come down to the Bank of Canada's target range, likely setting the stage for an interest rate cut as early as next week.

What has changed since Clinton's day?  A few thoughts come to mind. The first is that perceptions of what constitutes a "good" economy have evolved. In Clinton's day it was still common to hear talk of the "misery index", calculated by adding the inflation and unemployment rates together. Evidently that no longer works.  After a couple of decades of persistently low inflation, the surge in prices that resulted mainly from the COVID pandemic was an entirely new experience for much of the electorate, and they didn't much like it. It's true that unemployment briefly spiked higher during COVID, but it's worth keeping in mind that even in a very weak economy, unemployment may only affect 10 percent of the population, whereas inflation is felt by everyone. 

Then there's the change in the availability of information. The days when media outlets employed full-time business reporters who could accurately convey economic data to the public are largely gone.  Looking at inflation again, it would be hard to find an economics writer at most newspapers today who could accurately describe the difference between disinflation (which most countries now have) and deflation (which they don't, and in truth really don't want). News obtained from social media sites is even worse: there seems to be a small army of people out there who see it as their mission to peddle as much disinformation about the state of the economy (and of the world in general) as they possibly can. 

Another aspect of the explosion of social media is the increased polarization of the electorate. Traditional media certainly hosted a wide range of opinions, but the tone was generally respectful and tolerant. Those are not words that can be used to describe the discourse on social media, where innumerable people hide behind their anonymity to post views that would clearly have attracted lawsuits in gentler times. The belligerent tone of social media has, perhaps inevitably, spilled back onto the traditional outlets. Take a look some time at the home page of the London Daily Telegraph -- the paper's columnists are in a scarcely concealed state of rage at the state they perceive the country to be in, and the cataclysm that awaits if the voters are foolish enough to vote Labour in July. (Do yourself a favour and don't read any of the actual articles).

As things stand, it looks as if Messrs Sunak, Biden and Trudeau will all be lined up at the unemployment office the day after voting day, despite the healthy-ish economies they oversee. It's not as if their likely replacements are at all inspiring -- in the UK, Keir Starmer is dull and unambitious; in the US, well, nothing to add here; and in Canada, Pierre Poilievre is a shrill right-winger with no real-world experience to speak of. In all three countries, it looks like change for change's sake is what the voters want. 

That should do it

Canada's headline consumer price index (CPI) rose 2.7 percent in April from a year ago, the slowest annual increase in just over three years, according to data published by Statistics Canada this morning. The details of the report suggest that the way is now open for the Bank of Canada to start the long-awaited easing cycle at its Governing Council meeting on June 5.

The three "usual suspects" that have been largely responsible for pushing CPI higher in the current cycle are now down to two. Gasoline prices were up 6.1 percent year-on-year in April, up from 4.5 percent in March; this reflected the usual switch to more expensive summer blends and the Federal government's carbon tax increase at the start of the month. Shelter costs also continue to rise rapidly, advancing 6.4 percent from a year earlier.  High mortgage costs and pressure on rents from rapid, immigration-driven population increases are behind the continued pressure in this category. 

It is, however, a different and more encouraging story for food prices, the source of so much angst for both consumers and the government over the past year. The annual increase for food purchased from stores slipped to 1.4 percent in April from March's 1.9 percent reading.  The Federal government has made a big show of putting pressure on the large supermarket chains to keep food prices down, proposing to introduce a grocery "Code of Conduct". Can the government now legitimately claim credit for the fall in food price inflation? Well, just this week the largest of the supermarkets, Loblaw, announced it would be willing to sign up to the Code of Conduct after strongly opposing it for many months. The most likely explanation is that the company now believes that the underlying cost pressures that it has always blamed for higher in-store prices have now abated, which has very little to do with the government. 

The Bank of Canada's favoured measures of core inflation are also reflecting the waning of price pressures. All three of those measures now stand below 3 percent -- that is, within the Bank's 1 - 3 percent target range -- with their mean value at 2.7 percent. 

All in all, today's data will likely allow the Bank to implement a 25 basis point rate cut in early June.  However, it is probable the Bank will signal that it will proceed cautiously from there: consumers and markets should not expect further cuts at every Governing Council meeting for the rest of the year. With inflation still above the midpoint of the target range and the US Fed unlikely to cut the funds rate much before year-end, the Bank is unlikely to cut rates by more than 75 basis points in aggregate this year. 

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.