United States Highlights
- A good week for economic data as the ISM manufacturing index and the payroll report surprised on the upside.
- Details from both reports showed improvements on the supply side of the economy due to lower inflow from manufacturers
- prices and a strong improvement in the labor force were felt.
- The Fed still has its hands full to get inflation under control, but improvements on the supply side could make the job much easier.
- GDP fell short of expectations, but is still above trend as households continue to consume.
- Household savings declined in the second quarter but remain high compared to pre-pandemic levels.
- According to recent national accounts data, the Canadian economy is still in a period of excess demand and further rate hikes will be needed next week from the Bank of Canada.
United States – Good news on global supply
Markets continued to sell off this week as better-than-expected data dampened hopes of a 50 basis point hike by the Fed at its next September meeting. However, the ISM manufacturing report and the household employment survey gave reassuring signals that the supply side of the economy continues to improve and could help moderate inflation. The Fed will continue its hike cycle, but improvements on the supply side may just make it a little easier to control inflation.
Strong data on Tuesday’s job openings from the JOLTS survey grabbed headlines. Private openings in July were north of 10 million. Although sky-high job offers have become the norm, they stand out against history and represent the magnitude of the problem the Fed is seeking to address. To control inflation, officials hope to lower the rate of job openings, without significantly increasing the unemployment rate. There are few historical precedents for this, but there are also few modern historical precedents for what has happened in the economy over the past two years. Nonetheless, with job vacancies still high, the labor market is signaling that job demand remained robust in July despite rising interest rates.
The good economic news continued yesterday as the ISM manufacturing index surprised on the upside in August, recording a nice print of 52.8. Growth and output have been significantly slower than at the start of the recovery, but that was to be expected as the economy continues to operate in excess demand territory. The details of the report were also solid. New orders returned to growth and employment rose during the month. For the Fed, there was good news on supply chains as the supplier delivery index remained unchanged and input price growth slowed to its lowest rate since the summer of 2020. [Chart 1].
This was all a buildup to today’s jobs report. Consensus expectations were for nearly 300,000 new jobs, an impression that would be considered “good” in any expansion, let alone an impression that rebounded so little in turnout. Well, the data is slightly better than expected, with payrolls adding 312,000 jobs, but it’s the household report that has some positives. August showed there was finally a big move back into the labor market, 786,000 to be exact [Chart 2]. This helped push up the labor force participation rate by 0.3 percentage point to 62.4% and brought much-needed supply to the labor market. As the labor force grew faster than employment, the unemployment rate reached 3.7%. With just a little more labor supply, average weekly earnings moderated to 0.3% month-on-month from 0.5% the previous month.
The Fed will see this report as good news. The tight labor market is a key factor in setting salary expectations, and with more workers arriving on the sidelines, that means just a little less wage pressure. That said, labor markets remain tight as wage growth is still 5.2% year-over-year and inflation is still high. The Fed will continue to raise rates to fight inflation, but this week’s data suggests that some of the supply-side factors driving the current price growth are finally starting to subside.
Canada – Full steam ahead to raise fares
All eyes were on the GDP figures this week ahead of the Bank of Canada’s interest rate announcement on September 7th. Canada’s second quarter GDP figures came in at 3.3% annualized quarterly growth (q/q), and while this was below expectations, it is still above trend and outperforming our global counterparts. While there are signs of a slowdown, this GDP report justifies the sentiment expressed in the Bank of Canada’s most recent Monetary Policy Report that the economy is experiencing excess demand and will require further rate hikes of interest. Reflecting this expectation, bond yields rose, with the Canadian 2-year yield hitting a high of 3.7%, the highest level in 14 years.
Canadian growth in the second quarter was dominated by the strength of household consumption, non-residential investment and inventories (graph 1). Canadian consumers increased their spending by 9.7% q/q, with consumption of services being the main driver (16.4% q/q). This reflects the strength of the reopening of the economy after the covid shutdowns and the shift from goods to services. Non-residential investment in structures (11.1% q/q) as well as machinery and equipment (19.3% q/q) also supported growth. This has been fueled by the expansion of oil and gas companies in the western provinces which are benefiting from higher energy prices. On the other hand, growth in residential construction fell sharply (-27.6% q/q), reflecting the impact of the Bank of Canada’s aggressive rate hike cycle. Indeed, in our latest report on the Canadian housing outlook, we note that national Canadian home prices in the second quarter fell 9% q/q and could fall further. This should weigh on residential investment, putting downward pressure on GDP growth going forward.
Although real GDP came in below most forecasters’ expectations, nominal GDP growth came in at 18% q/q, down from 16% q/q in the first quarter. This boosted nominal household disposable income in the second quarter (3.9%), as wages and salaries increased by 7.8%. With this income gain, combined with still high household consumption, the savings rate fell from 9.5% to 6.2% (Chart 2). As inflation is expected to remain high and interest rates are expected to rise further, we expect consumers to re-evaluate their spending habits, which could lead to a further drop in the savings rate in the next quarter.
With this GDP report in its back pocket, we expect the Bank of Canada to continue raising rates next week, with 50 basis points as the floor, as markets are already pricing in a 75 basis point hike. basic. It is clear that the economy continues to operate well beyond its excess capacity and needs higher interest rates to ease current inflationary pressures.