Ian is joined this week by Avery Shenfeld, Chief Economist at CIBC. The duo begin the episode discussing the most recent North American jobs reports, with Avery highlighting why the Fed hasn’t yet done enough to cool the hot jobs market. Ian outlines the reasons not to get too wrapped-up in Canada’s recent wage gains, while Avery provides his view on the recent increase in the Unemployment Rate. The pair spend some time discussing the outlook for monetary policy, concluding that September is still very much in play for the Bank of Canada despite a string of weaker-than-expected activity data. The show finishes with Ian discussing the recent volatility in global long-bonds.
Avery Shenfeld: To some extent, our forecast is now sitting a little bit on the fence. I think that the CPI is going to be the tiebreaker. If we got some pleasant news there and some of the underlying measures that the Bank of Canada tracks. that would give them, I think, reason to come out in September, not to say that they’re done, but to say that there’s a trend towards a slower economy.
Ian Pollick: You know, I’d be remiss if I didn’t say that. I don’t know how we’ve done 67 episodes and our Chief Economist, Avery Shenfeld has not been on the show. And so we’re fixing that today. I’m joined today by Avery Shenfeld. Avery, how are you?
Avery Shenfeld: I’m great, and it’s great to be here.
Ian Pollick: We are glad to have you. So let’s just kick into it, okay? There’s a lot going on this week with US CPI. We have some reverberations from the jobs report last week and maybe that’s a logical place to start. So, you know, talk to me about what you saw in the US data. Was it concerning? Was it too far away from your expectation? Anything that helps inform your view on the Fed?
Avery Shenfeld: Well, it was pretty much a yawner in the sense that it was about what we thought it would look like. A middling but probably still somewhat too strong jobs number. I mean, we’re still getting in the 175,000 range. We really need to be down to the roughly 100,000 range. And the proof of that is we’re not seeing an uptrend in the unemployment rate. And the Fed is pretty much unanimous in its view that they need some increase in the unemployment rate to cool wages. And of course, the wage number, another 0.4 increase month over month. We’ve had a few smatterings of 0.3s every now and then here, but by and large, we’re trending at around 0.4 a month. Again, that’s better than we were at some points, but still a bit too hot. So encouraging, but not yet the definitive slowing that we need to see for the Fed to really put away any risk of another rate hike being necessary.
Ian Pollick: So let me ask you this, you said something about, you know, that base of 100,000, is that the level by which, and I just wanna make sure I understand what you’re saying, that it is too far below population growth and that’s the level that gets the unemployment rate rising?
Avery Shenfeld: Something in the vicinity of 100,000 might be enough to have the unemployment rate moving up very gradually. But that’s what actually I think the Fed would like to see now. The hawks on the Fed, who at one point seemed to be thinking that we absolutely had to have a serious recession to get inflation down, they’ve pretty much been silenced by the downtrend that we’ve seen in various inflation metrics. So, nobody right now on the Fed really is hunkering down and hoping for a recession, but they’re still hoping for a landing of some sort and a somewhat higher unemployment rate and a number in the vicinity of 100,000 on payrolls would typically translate into the kind of household survey that would see the unemployment rate doing that slow drift higher.
Ian Pollick: So let me ask you this, you know, one of the things I was looking at in the US jobs report was hours worked. And I must confess, I honestly don’t spend a huge amount of time looking at it, but from a trend perspective, you know, you are now basically back to pre-pandemic levels in terms of hours worked. So from your perspective, and just share with us your views, you have ongoing labor market gains, you have hours worked that’s declining and wages going up. And so is this a productivity issue in the US? Like, how do you think about that?
Avery Shenfeld: So around the world, there is still a productivity issue in the sense that supply chains aren’t fully healed. That’s certainly part of the problem. One thing that we’ve seen in the US is that the participation rate, if you remember, it was quite low. At the height of the pandemic, there was all this talk about, take this job and shove it, people leaving the labour market for good. If you look at the people under 55 and over 25, the prime age workers, we’ve pretty much erased that. So we’ve had a pretty strong recovery in labor force participation. That does mean, however, that we don’t have that elbow room now to generate a lot of jobs by increasing labour force participation further, and therefore not creating tightness and wage inflation. So I think overall, the numbers aren’t entirely always fully explicable here. But I think the key to me is that the wage inflation numbers are still too hot. It is giving the Fed a signal then that they do need some additional slack in the labor market, either from a moderate rise in the unemployment rate or a further decline in the job vacancy rate. And my suspicion is we’ll get a bit of both.
Ian Pollick: Okay, so let’s do a little compare and contrast here because obviously we got the Canadian numbers at the same time. And I think at least for market participants, the biggest what the moment was with Canadian wages. You know, we had positive base effects that were always gonna push the level of weight or the wage pace higher, but it was a bit more than expected. And so when I kind of looked at the data, what was interesting to me is that you had a lot of overtime hours worked, it looks like in manufacturing, I suspect. And also in areas like construction, you shed like 50,000 jobs, but your wage rate went up. Is this just a situation where you’re losing lower paid workers and so the wage pie is flatter and therefore it’s not exactly as strong as people would be looking at on a headline?
Avery Shenfeld: That was a very nuanced question, but I’m going to answer with something that doesn’t address any of that, which is that the wage numbers in this particular survey are not particularly useful or reliable. So I wouldn’t really read anything into the wage numbers that come with the labor force survey. In fact, I’ve been doing this job long enough that I remember that when I first started at CIBC, there was no wage number in this survey of households because it’s just too unreliable. So there are four wage series for Canada. Two are quarterly. two are monthly. The other monthly one from the survey of businesses, the CEF data as they call it, is probably a bit more reliable, but still volatile. But actually the two numbers that the Bank of Canada pays most attention to are two series that are only reported quarterly. One from the national counts, one from the productivity data. But I think that this particular jump really just brought this LFS data back into line with the others. It does seem that from all the various wage indicators that we can look at, including the more reliable ones, that wages probably are trending at somewhere between 4% and 5% year over year, which again-
Ian Pollick: That’s high. That’s high relative to
Avery Shenfeld: Still to high. Very much the same story as the US. We’re getting some slackening in the labour market, but it has yet is not enough to cool that wage inflation.
Ian Pollick: So let me ask you this, 6,500 jobs lost, first job loss outright in quite a while. We’re now in a world where because of the population growth, we need these very large monthly prints just to maintain the size. And so when you have a negative print, obviously it does a lot of movement in the unemployment rate. Canada’s unemployment rate has moved five tenths or four tenths in the past few months. Is that enough for the bank? Like, is this moving in for the right reasons or is this a function of people bringing their supply back into the market because wages are still so high?
Avery Shenfeld: I think we have a trend that ought to be encouraging for the Bank of Canada. Again, I don’t place too much emphasis on one monthly number from a household survey, which is what that latest uptick in unemployment or the drop in employment, if you actually believe that number. But what I do believe is that we were running around a 5% unemployment rate. We’re now up to five and a half. And our view is that a number like 5.8 or 5.9, might be high enough judging from historical relationships, coupled with a decline in job vacancies, which is underway as well in Canada, that if we got that combination, it would be enough to bring down that wage inflation over time. So the Bank of Canada ought to be looking at this and saying, we’re not going to read too much into one monthly number, but there is a trend here towards a higher unemployment rate. That’s what we’re looking for. And so it isn’t clear that we should be continuing to raise rates. Now, I would have argued the same thing when they met in July. We’ve had an uptick in the unemployment rate for a couple of months in a row. And I think at that point they could have said, why don’t we just see how these numbers go for a while before deciding that we need to continue to hike? Of course, they did end up hiking. And they might well use the same logic in September. They might decide that, yeah, the unemployment rate’s moving up, but wages are still too hot, and we don’t have enough of a trend here to be assured that it’s gonna continue in that direction. But my personal view is, they have plenty of reason to say the jobless rate is now trending higher, not just for one month, but actually three months in a row where the unemployment rate has moved up. And that’s what they’re looking for. So they certainly have a reason to at least pause, see how things go, but their impatience in the July meeting isn’t so encouraging for what they might choose to do in September.
Ian Pollick: For sure, and let’s just add some context to this discussion because this is super important. So as a firm, you know, we’re looking for an additional hike, not that necessarily we believe that it needs to happen, but their past reaction functions suggest that it could happen. There are cracks starting to form. We’re seeing it in, you know, the trade balance in particular suggests that at least net trade, or I know you don’t like net trade, so exports will not be as meaningful to GDP going forward. There’s some decline in real retail sales in the sectors that are most rate sensitive. You have what we just talked about, the labour market. So for our clients, in your perspective, you had a slight miss to GDP, and I stress the word slight. You had a miss to the jobs report, which again was pretty slight. Is it CPI being the tie that binds everything? Is that the most important piece of data for them? And just, I wanna know what your thoughts are.
Avery Shenfeld: I think that’s absolutely right. The Bank of Canada is still an inflation targeting central bank. Let’s not forget that. And so I think that because they’re on the fence here for September, and frankly, to some extent, our forecast is now sitting a little bit on the fence. I think that the CPI is going to be the tiebreaker. If we got some pleasant news there and some of the underlying measures that the Bank of Canada tracks. that would give them, I think, reason to come out in September, not to say that they’re done, but to say that there’s a trend towards a slower economy and a higher unemployment rate, and maybe we should see how far that trend goes before judging that we need to raise again. But if the CPI is disappointing to the bank, and again, you know, some of-
Ian Pollick: Disappointing meaning too high.
Avery Shenfeld: Yeah, just too high, not trending lower on some of those underlying core measures that they track, and there are several of them. But if the preponderance of those are still too high and not decelerating further, I think they’ll likely again be too impatient and hike again in September. So September is still a very live meeting and the CPI will be the tiebreaker here.
Ian Pollick: So let’s just talk about a couple things. And I don’t want to get you too granular here, but obviously we’ve had a very big move in gasoline prices. They’re up 8% kind of June, July. They are sitting right now where we had expected them to be by December, which argues for a little bit of potential upside. And so how are you thinking about the movement energy prices vis-a-vis just, you know, your updated CPI forecasts?
Avery Shenfeld: Given the volatility that you have in WTI or Brent, it’s not a stunner to me that we reached our year end level a little bit early or almost a half year early, I suppose. The Saudis are really the ones driving this bus. They’ve been pairing back output. It’s pretty clear that they would like oil to trend around $80 a barrel because When it’s well below, that’s when they that’s when they’re prepared to cut production even if they’re doing it solo. So it doesn’t surprise me that we’re sitting around 80. I would suspect that at the end of the year we’re still around 80 because we do we are seeing a slowing in global economic activity that’s not going to be too helpful to push oil higher from here and I would say that on balance It’s not a huge issue for the central banks that were back at $80 a barrel. Remember that they were sort of discounting the decline in inflation caused by year over year drops in gasoline prices. Similarly, I don’t think there’ll be too worried about gasoline ceasing to be a disinflationary force. If we slow job and wage growth, then the reality is that yes, people might be now having to spend a little more of their income, filling up their tank. but that will just leave less spending power elsewhere in the economy and that could actually force a little bit more disinflation somewhere else. So they’re really heavily focused on spending power. And I think that investors should be as well. If we get a deceleration in job and wage growth, we’ll be pretty confident that inflation has to follow suit. Even if gasoline prices are a little elevated, spending power elsewhere in the economy won’t support above 2% inflation if wages have cooled a lot and employment growth has slowed.
Ian Pollick: Okay, so let’s look on the other side of this. Okay, so just to summarize, we have the Fed going, either September, maybe November, but very likely that they match their projections in the in the SEP and they do another hike. September is very live for the Bank of Canada, potentially even October, if conditions are right. Talking about the other side of this, right? So when we look at our forecast for 2024, and we look at interest rate cuts, part of it is just a function of real policy rates getting too high, and you kind of have to cut rates just to stand still. But obviously you have this situation where the market’s looking for a lot of cuts from the Fed, not that many cuts from the Bank of Canada. In the world, according to Avery Shenfeld, what is the prescription here? Is that appropriate that you see the Fed out cut the bank? Or is the market a little too much for the Fed, a little too little for the Bank of Canada?
Avery Shenfeld: I don’t actually understand what the market is thinking here. Maybe they’re excited about oil prices moving up and think that Canada is going to be a huge winner there, but nobody’s launching a new oil sands facility the last I looked. I think the reality is that the US and Canada both share one reason to start cutting next year, which is that as inflation comes down, as you pointed out, real interest rates would otherwise be rising, at least in the short end of the curve because longer term real rates depend on longer term inflation expectations. They may not be moving that much, but I think that’s one reason, equal reason for both to cut. But Canada has its own unique reason, which is that mortgage renewals will be particularly punitive in 2025 and 2026 if interest rates aren’t at that point significantly lower because we will be hitting the four and five year anniversary of people having taken out. very, very low mortgage rates in 2020 or 2021. And that’s something that the US doesn’t share. They have their mortgages locked in. So I think the Bank of Canada is well aware of this issue that for now they’re happy to be putting the squeeze on mortgage borrowers. That’s part of slowing the economy. But once the economy has slowed and inflation has cooled, if you don’t bring down interest rates, actually, the punishment for mortgage renewals will be higher in 25 and 26. So, if anything, there’s more reason for the Bank of Canada to outgun the Fed on rate cuts in 2024. I certainly don’t see an obvious reason why the Fed would be cutting more aggressively.
Ian Pollick: Let me ask you this, right? I mean, you’re in a situation where, and I can totally appreciate that view. You know, you have a squeeze on right now that’s very much by design because you’re right sizing demand. But does the bank really wanna support this entire mortgage market? Like is that a reason for them to cut interest rates? If, for example, we do have this soft landing where you don’t have a huge increase in the unemployment rate. Doesn’t it just mean that the overnight rate wherever it gets to is probably at a higher level than most expect?
Avery Shenfeld: Yeah, I think I would say they don’t necessarily want to support the mortgage market, but they don’t want to crush the homeowners whose mortgages are renewing. So remember that someone who took out a mortgage in 2020 took it out at extremely low interest rates. I’m quite comfortable that the Bank of Canada will think that when those mortgages come due in 2025, for example for a five year mortgage, that they don’t mind if people have to renew at a significantly higher rate than they got in 2020. But the gap or the punishment at these sorts of interest rates will be just too much of a downshift for the Canadian economy if we’ve already cured the inflation problem at that point. So it’s moving to a more neutral, not aggressive stance to help the housing market, to help homeowners. But taking away some of the punishment that we would otherwise face if rates just plateaued at these levels and stayed there for a couple of years, I think that would be far too much of a headwind for the Canadian economy in 25 and 26.
Ian Pollick: Yeah, especially if the labour market starts to crack and you get, you know, a nearer six percent unemployment rate.
Avery Shenfeld: So I’m going to ask you something, Ian, which is that the bond market last week in particular seemed to suddenly be a lot more nervous about supply, maybe also getting a little more nervous about the long-term inflation outlook. Today, it seems a little bit calmer waters, but do you think that this sort of supply impact can stand in the way of a meaningful rally at the long end if we were to… see the end of Fed hikes? Or is there gonna be a tug of war that favours a rallying bond market even with the extra supply?
Ian Pollick: I mean, it’s a great question, right? And just to put some context around it, what we saw last week was pretty scary. You saw a few sessions where global long bonds and really across the developed market were extremely weak that coincided with the US downgrade by Fitch, but also the announcement by the Treasury that the refunding would be considerably larger in Q4. And so we’ve done the math a bit. And when you kind of convert everything into 10-year equivalents, the net amount of duration that’s hitting the US market via supply is growing pretty substantially on a year-over-year basis. And historically, when you see moves like that, it’s very correlated to the term premium. And so I can see a situation where long-term interest rates are starting to rise or underperform the short end on expectations that you’ll have a higher clearing level for supply. Most of the way that rates actually sold off last week was through higher real interest rates. And so your breakeven component actually declined. And to me, that’s really worrying because it’s just the market demanding a higher clearing rate. But for other asset classes like equities, when you have rising real interest rates of that speed, it’s very damning. And so the most interesting part of it was that you shouldn’t be seeing a steeper yield curve right now led by higher long-term rates. It is the opposite type of steepener that most people expected to see, which is what we traditionally know near the end of a cycle is short-term interest rates rally as interest rate cuts get priced and the short end outperforms. You know, my sense is that you could have more weakness than people expect in longer term interest rates because they’re not capped, they’re totally unbounded. Whereas the short end, it’s not gonna go to zero because we’re not gonna get that many cuts and it’s not going to 10% because we’re not getting that many hikes. And so because of that, I think it makes sense that at least in the very near term. And we saw this yesterday, you know, the yield curve will flatten led by lower interest rates and it’ll steepen led by higher interest rates. And that’s a bit unusual for the stage in the cycle.
Avery Shenfeld: And do you see this story still having more to go here, or has the market now adjusted, given the announcement from the Treasury, to the reality of a sustained higher funding requirement?
Ian Pollick: I think the reality is we have to see how auctions go this week. We have 110 billion of U.S. auctions across three years, 10 years, and 30 years. I suspect that the 10-year won’t be terribly bad, just given its proximity to 4%. The 30-year comes right after inflation, and so I think that’ll just be totally dependent on how the inflation report goes. But this is a very big week this week. And not to mention, the Treasury did talk about going forward, the deficit is just so large that issuance will have to rise further. And so when you kind of think about the level of free float in global bond markets, which is rising, we associate that with a higher term premia. I think ultimately you can still have lower yields, but yields that’ll still be relatively higher compared to either the data surprises that we’re seeing or the interest rate cuts that are priced into the market.
Avery Shenfeld: So a less good rally, but a rally coming nevertheless at some point, maybe before the end of the year.
Ian Pollick: Correct. So listen, we’ve been gabbing for about 20 minutes now. Any last thoughts before we let this episode go?
Avery Shenfeld: Well, I think you hit it on the head when you talked about, you know, the US inflation numbers coming out, the Canadian inflation numbers coming out. So we put the jobs numbers behind us. We’re really in the period now in the next couple of weeks where the focus is gonna be on these inflation numbers.
Ian Pollick: Oh, look, Avery, I know you’re a busy guy. Thank you very much for joining us. And I promise you, it won’t be another 67 episodes until we have you on again. For everyone listening at home, thank you very much for joining the episode. And remember, there are no bonds harmed in the making of this podcast.
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