The year so far has seen more than a few gyrations on what was as we entered it expected to be a year of interest-rate cuts from the US Federal Reserve The starting gun on this was fired by no less than the Chair of the Federal Reserve Jerome Powell. The time that the ten-year yield went below 3.8% seems like from another world now and in a way it was. After all one of the theories was that the interest-rate cuts would help the reelection of President Joe Biden. How did that one work out?
Yesterday though things moved on again and one of the factors was this.
The Bank of Canada today reduced its target for the overnight rate to 4½%, with the Bank Rate at 4¾% and the deposit rate at 4½%. The Bank is continuing its policy of balance sheet normalization.
As an aside there is an inconsistency in reducing your balance sheet was you can interest-rates as all things being equal it will raise bond yields. But I note few seem to even question this. But the fundamental point is that whilst we are out of the King Dollar phase which meant the Bank of Canada was mostly a forerunner for the Federal Reserve there still are influences.
Plus they gave us a view on the US economy.
In the United States, the anticipated economic slowdown is materializing, with consumption growth moderating. US inflation looks to have resumed its downward path.
Although care is needed as they seem to have no idea what is going on in the Euro area.
In the euro area, growth is picking up following a weak 2023.
Switching to Canada this is a fascinating comment as whilst the economy has grown in aggregate on an individual basis things are retreating.
In Canada, economic growth likely picked up to about 1½% through the first half of this year. However, with robust population growth of about 3%, the economy’s potential output is still growing faster than GDP, which means excess supply has increased.
If you take their numbers literally then on an individual basis GDP is falling at an annual rate of 1.5% which presumably explains things like this.
Household spending, including both consumer purchases and housing, has been weak.
Plus we see this.
There are signs of slack in the labour market. The unemployment rate has risen to 6.4%, with employment continuing to grow more slowly than the labour force and job seekers taking longer to find work.
Then we see what turns out to be something of a reverse ferret. You start off with a better economy but then discover they seem to be suggesting further interest-rate cuts and the emphasis is mine.
GDP growth is forecast to increase in the second half of 2024 and through 2025. This reflects stronger exports and a recovery in household spending and business investment as borrowing costs ease.
That theme has fed through to markets who are now expecting interest-rates to head to at least 4% and maybe lower. Now whilst there are differences between the Canadian and US economies there are also plenty of connections and there is a clear implied view here for what we can expect from US interest-rates.
My Themes
Two of them are in play here. Firstly the one that argues that central bankers care most about house prices.
The national index decreased by 0.2% in June as compared with May. Prices were down in 10 of the 27 census metropolitan areas (CMAs) surveyed in June and unchanged in 12, while prices rose in the remaining 5 CMAs. ( Statistics Canada)
Next up the problems with measuring inflation.
At the same time, price pressures in some important parts of the economy—notably shelter and some other services—are holding inflation up.
How is shelter holding it up as house prices fall? Also as we have noted before Canada has mortgage interest-rates in its target which will now be falling.
William Dudley
The former head of the New York Fed entered the chat yesterday in a piece for Bloomberg.
I’ve long been in the “higher for longer” camp, insisting that the US Federal Reserve must hold short-term interest rates at the current level or higher to get inflation under control.
The facts have changed, so I’ve changed my mind. The Fed should cut, preferably at next week’s policy-making meeting.
That would put le chat avec les oiseaux. Remember central bankers are pack animals and tend to think the same things, so there is particular significance in this.That is before we wonder if his role is to put such thoughts into the public arena as a type of wind vane? Let us examine his reasoning.
Most troubling, the three-month average unemployment rate is up 0.43 percentage point from its low point in the prior 12 months — very close to the 0.5 threshold that, as identified by the Sahm Rule, has invariably signaled a US recession.
As you can see he is worried about the labour market and the rise in unemployment. Switching to employment many will be unaware of the gap between the 2 main Bureau of Labor Statistics surveys and he has chosen the weaker one.
Slower growth, in turn, means fewer jobs. The household employment survey shows just 195,000 added over the past 12 months. The ratio of unfilled jobs to unemployed workers, at 1.2, is back where it was before the pandemic.
Also he notes a decline in wage growth.
On the wage front, average hourly earnings were up 3.9% in June from a year earlier, compared with a peak of nearly 6% in March 2022.
In these terms the mention of inflation is a bit of an afterthought.
Meanwhile, inflation pressures have abated significantly after a series of upside surprises earlier this year.
Oh and if the name sounds familiar he is the chap that received the “I can’t eat an I-pad” riposte.
A Weakening Economy?
Also we saw this from S&P Global.
The S&P Global Flash US Manufacturing PMI fell from
51.6 in June to 49.5 in July, signaling a deterioration in
business conditions within the goods-producing sector for
the first time since December.
But whilst it flashed a warning it is also true that the overall message was for growth.
“Output across manufacturing and services is expanding
at the strongest rate for over two years in July, the survey
data indicative of GDP rising at an annualized rate of 2.5%
after a 2.0% gain was signaled for the second quarter.”
The Atlanta Fed is sending out a similar message.
The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the second quarter of 2024 is 2.6 percent on July 24, down from 2.7 percent on July 17.
So on this basis the rate cut view would be relying on manufacturing leading the rest of the economy.
Comment
As you can see the ground has been shifting a bit on interest-rate cuts.Plus yesterday there was movement in something else mentioned in the piece by William Dudley.
Easing financial conditions — particularly a surging stock market — increased wealthier households’ propensity to consume.
As well as it being kind of him to confirm my theme that central bankers are obsessed with wealth effects there was also this yesterday.
Call your mom. S&P500 closed below 2% for the first time in 356 days……The Nasdaq 100 had its worse close since 2002, down 3.65%. ( @unusual_whales)
That brings us to the issue of the Plunge Protection Team and the equity market put option. How far will they let the equity market fall?
Personally I am still not expecting an interest-rate cut next week but we do now seem likely to get more confirmation of a September one and what if they hinted at 0.5%? It looks as though we are being warmed up for something.