E-Sight Weekly: Canada posts solid job creation, wage growth accelerates, Macklem hawkish

The latest Canadian employment report once again showed an economy with momentum and struggling with labour shortages. 40 thousand net new jobs were created in the month of May, which is a strong performance – an average monthly gain is around 20-25 thousand. The composition of job growth was healthy, with 135 thousand net new full-time positions offsetting the loss of 96 thousand part-time jobs. The unemployment rate edged down to a new record low 5.1 per cent. Wage growth accelerated to 3.9 per cent year-over-year from 3.3 per cent in the prior month. However, it is worth stressing that much of the wage acceleration over the past year has come from a shift in the occupational mix of the job creation, with more higher-paid positions being added during the employment recovery. Nevertheless, business surveys have consistently shown more than a third of employers reporting labour shortages. The one disappointment in the report was news of a 0.3 per cent decline in total hours worked in May. This is consistent with the Deloitte Economic Advisory forecast that an economic slowdown began in the spring, but the economy still had considerable impetus.

The Labour Force Survey will not have provided any comfort to the Bank of Canada, which acknowledges that it has fallen behind the inflation curve and is playing catch up. Indeed, while the Bank’s Financial System Review (FSR) publication released last week sounded alarm bells about excessive household debt and overvalued home prices, Governor Macklem indicated that, “the likelihood that the [overnight] rate will need to go to the top of the 2-3% range or possibly somewhat above it…has increased.” This is very transparent, hawkish messaging and has been interpreted as potentially signaling a 75 basis point hike in July – I still expect a 50 basis point increase. Financial market have priced aggressive tightening, with the yield on the 5-year Government of Canada bond having risen almost 3 percentage points from its pandemic low – the importance being that 5-year mortgage rates tend to track the change in 5-year Government of Canada bond yields with a lag. 

As we discussed last week, the combination of a rapidly rising cost of living and higher debt service costs are bound to bite into consumer spending in the months ahead. The pool of pandemic saving has been acting as a buffer, but by the fall or winter it is likely that retail activity will be showing signs of weakness. Residential real estate is already cooling, but this is only the start of a turn in the cycle. Given the dramatic rise in prices in recent years, a price correction would be appropriate and weaker real estate activity would dampen housing-related consumer purchases. 

Last week I also flagged that Canadian economic risks are tied to US economic fortunes. As the adage goes, if the US sneezes, Canada gets pneumonia. Canada is leveraged to the US through its deeply integrated trade ties. And, the economic risks are building in America. The US Consumer Price Index for May surprised on the upside, lifting inflation to a 40-year high of 8.6 per cent. Energy and food prices were major contributors. Stripping out their effects, core inflation edged down 0.2 percentage points to a still-rapid 6.0 per cent. Worryingly, price growth within the core CPI components was broad based. The implication is that the Federal Reserve has considerable work to do to rein in inflation. Look for the Fed to hike by 50 basis points at its FOMC meeting this coming Wednesday and to continue its monetary policy cycle through the summer and into the Fall. This will moderate US economic growth and help to address inflation and inflation expectations, but will also have global implications, through America’s trade ties but also reflecting the fact that international government bond yields trade as spreads to US Treasuries – meaning a tightening of US monetary policy creates a tightening of global financial conditions.  The Federal Reserve and the Bank of Canada are expected to broadly move in tandem and to a similar degree in tightening policy. Moreover, both economies are likely to experience significant slowdowns in the second half of this year and early next year. This will fuel considerable recession talk. I would put the odds of a recession at 1 in 3. Not the most like, but quite possible given the economic environment and challenges.

Categories: Bank of Canada, Canadian Economic Outlook, Canadian Employment, E-Sight, Economics

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