Do you think the Bank of Canada should follow suit?

General 17 Dec

For the first time in nine years, the U.S. Federal Reserve hiked their key policy rate–the overnight federal funds rate–by one-quarter percentage point (25 basis points) to a range of 1/4 to 1/2 percent. The policy-making Federal Open Market Committee (FOMC) said that the stance of monetary policy remains accommodative, thereby supporting further improvement in the labor market and a return to 2 percent inflation.

The U.S. labor market has improved considerably this year taking the unemployment rate down to 5%, while inflation has been depressed by falling commodity prices and the strength in the U.S. dollar.

Importantly, the Fed suggests that they expect economic conditions to warrant only gradual increases in the federal funds rate and that the funds rate will remain below levels that are expected to prevail in the longer run for some time. Having said this, the Committee’s interest rate forecasts signaled four quarter-point increases in 2016, a stance that has been interpreted by the markets as relatively hawkish. This, of course, will be data dependent, and many economists expect fewer than four rate hikes next year.

The Canadian dollar, which has weakened sharply in recent weeks on further declines in oil prices, edged downward with the release of the Fed decision, but bounced back shortly thereafter. U.S. Treasuries tumbled on the news pushing market rates higher. U.S. stocks, on the other hand, extended today’s gains and the yield on two-year Treasury notes topped 1 percent for the first time in five years after the Fed ended seven years of near-zero interest rates and reaffirmed gradual tightening over the next year. The yield on the ten-year Treasury bond edged up slightly to 2.29 percent.

Bank of Canada Will Remain On the Sidelines

The Canadian economy has been hard hit by the continuing decline in oil prices and other commodity prices. Not only has West Texas Intermediate crude oil, the price received in the U.S., fallen to roughly $36 a barrel, but the price received in Canada for heavy oil is substantially lower.

Economists expect that Governor Poloz will keep his benchmark overnight rate at 0.5 percent unchanged until at least 2017. Nevertheless, mortgage rates in Canada have likely bottomed as five-year market rates, to which mortgage rates are linked, are edging higher and lenders are pressured by very narrow interest rate spreads.

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Dr. Sherry Cooper

Chief Economist, Dominion Lending Centres
Sherry is an award-winning authority on finance and economics with over 30 years of bringing economic insights and clarity to Canadians.

Finance Minister Revises Government’s Economic Outlook – Dr. Sherry Cooper

General 23 Nov

Finance Minister Bill Morneau said today that Canada’s budget is deeper in the red than we were told in the 2015 budget as the economy’s performance has disappointed. He also revised down the government’s outlook for the economy over the next year. According to the Minister, the federal books are short roughly $3 billion in the current fiscal year and $3.9 billion in 2016-17, with deficits continuing through 2018-19–a significantly gloomier fiscal picture than was painted by the Conservatives and even by the most recent report of the Parliamentary Budget Committee.

However, a large portion of this worsened outlook is because the Liberals chose to adjust down their forecasts of economic growth to levels well below the downwardly revised levels predicted by private-sector economists, effectively adding a contingency reserve.

This lower growth forecast adds C$1.5 billion to the projected deficit for 2015-16 and $3.0 billion for each of the five years from 2016-17 on.

Without that economic adjustment, the deficits would be $1.5 billion for 2015-16 and $3.0 billion for each of the five years from 2016-17 on. Nevertheless, all of these projections exclude the Liberals’ impending budgetary stimulus initiatives.

When quizzed by reporters, Morneau would not say whether he remained committed to no more than an annual budget deficit of no more than $10 billion over the next three years. He provided no specifics on exactly what the update portends for the upcoming budget—the timing of which was not released—but asserted that the government would stimulate the economy in a prudent manner.

Analysis

I agree that there are downside risks to the global and Canadian economies. Canada has suffered a severe blow with the dramatic and sustained fall in oil and other commodity prices, the impact of which has not yet been fully felt throughout the economy. Minister Morneau agreed that further reductions in employment and activity in the resource sector are coming in contrast to what the former government and the Bank of Canada have asserted.

Canada’s federal balance sheet is in great shape thanks to years of austerity beginning in the 1990s. Our structural deficit has been obliterated, helped by the secular decline in interest rates. Moreover, our debt-to-GDP ratio is barely above 30%, at the bottom of the Organization for Economic Cooperation and Development (OECD) countries performance. The proposed deficit of $10 billion is only 0.5% of Canadian GDP—an extremely low number by global standards, well-below the level in the U.S. of about 2.4%.

Canada’s economy is in need of fiscal stimulus. The risk is too little, too late—not, an overflow of red ink. The U.S. made of mistake of insufficient government stimulus in the aftermath of the financial crisis. Canada should not make the same mistake now.

We have been hard hit by external forces that have driven down a very important sector of our economy. The hard won gains on the fiscal front give us the bandwidth to now take significant action to reboot economic activity and to improve our productivity and competitiveness over the next decade. We should seize that opportunity, which will no doubt entail running budget deficits in the near term of more than $10 billion.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres
drcooper@dominionlending.ca

Job Strength Means Fed Hikes Rates–Canadian Rates Have Bottomed – Dr. Sherry Cooper

General 6 Nov

The jobs numbers released today for October exceeded expectations in both the U.S. and Canada. This was a particularly important report for the U.S., because it all but insures that the Federal Reserve will hike rates for the first time in a decade when they next meet on December 16. Interest rates in both Canada and the U.S. had already risen in anticipation and the U.S. dollar has strengthened, taking the loonie down sharply this morning to 75.4 cents.

Payrolls in the U.S. climbed the most this year as the unemployment rate remained essentially unchanged at 5.0%–the lowest level since April 2008– providing the signs of labor market durability that the Fed is looking for. The 271,000 October jobs gain followed two months of weaker-than-expected employment. The improvement in October was led by the biggest gain in retail payrolls since November 2014, the strongest hiring in construction in eight months and a pickup at temporary-help agencies. Manufacturing showed no improvement.

Critically, wage growth strengthened–a key factor in the Fed’s decision making. Worker pay increased 2.5% over the year ended in October, the most in more than six years.

While the labor force participation rate remained at only 62.4%, the broadest measure of U.S. unemployment, which includes discouraged workers and those involuntarily working less than full-time, fell to 9.8%, its lowest level in since May 2008. Treasuries slid on the news, taking the U.S. ten-year yield up 10 basis points to 2.33% immediately following the release.The U.S. dollar surpassed this year’s highs.

Canadian Employment

Canadian employment also exceeded expectation in October, rising 44,000. The unemployment fell 0.1% to 7.0%. Unfortunately, much of the out-sized gain–32,000 of it–was in temporary workers hired in preparation for the federal election. Even so, employment growth was somewhat higher than expected.

Canadian hiring growth this year has been surprisingly strong given the marked job cuts in the oil and mining sectors. The natural resource category fell in October by 8,000, bringing the total losses in the industry to -26,000 (-6.9%) over the past 12 months. Most of the declines were in Alberta. According to Bloomberg News, job cuts from energy and commodity producers over the last month have come from Husky Energy Inc., Athabasca Oil Corp., Cenovus Energy Inc., Meg Energy Corp. and Devon Energy Corp. Husky Energy said October 30 it plans to keep cutting jobs after eliminating 1400 positions.

Employment in Alberta fell by 11,000 in October. Compared to a year ago, the jobless rate in the beleaguered province is up 2.2 percentage points to 6.6%. Unemployment in Saskatchewan has also risen year-over-year by 0.5 percentage points to 5.6%.

British Columbia boasts the strongest job market over the past 12 months, with employment growth of 64,000 or 3.0%.

Construction jobs were down -9,400 last month, bringing the year-over-year figure to -24,000. Manufacturing was up 6,500 taking the year-over-year figure to slightly positive territory. In the service sector, trade and finance job gains were sizable as were gains in health care and especially accommodation and food services.

Bottom Line For Canadian Housing

Mortgage and other borrowing rates in Canada have bottomed even though the Bank of Canada will not follow the Fed’s lead in raising overnight rates. Construction activity will continue to slow in 2016 in both the residential and non-residential sectors. Canadian housing, which has been red hot in Toronto and Vancouver, will also slow as housing affordability continues to deteriorate. House price gains in both cities will slow, especially in the condo sector. Supply constraints in the single-family sector have caused prices to surge once again this year–up a whopping 19.0% in Vancouver as of the year ending September and up 11.8% in Toronto over the same period (see chart below).

In contrast, price increases in the condo sector have been more muted in both cities. For the year ending September, condo prices were up 9.0% in Vancouver and only 5.6% in Toronto. For both cities, 2016 will be a more challenging year. I do not expect aggregate price declines in either city, but price gains will be considerably more muted.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres
drcooper@dominionlending.ca