United States Highlights
- Prices in the United States continued to climb in January as headline inflation accelerated to 7.5% year-on-year from 7.0% in December. Excluding food and energy, underlying prices also rose significantly over the year to 6.0%, with broad-based increases across all index constituents.
- High inflation has bolstered market expectations for aggressive monetary policy tightening as the Fed is due to meet in mid-March. Financial markets reacted with bond yields generally rising, while equities fell.
- For 2021, the United States posted a record trade deficit of $859 billion as imports increased.
- Census data released this week showed strong population growth in Canada from 2016 to 2021, laying the foundation for strong long-term economic prospects.
- The rate hike cycle is fast approaching, with Governor Macklem stressing that “a significant shift in monetary policy” will be needed to bring inflation back to its 2% target.
- Several provinces have outlined plans for a rollback of public health restrictions, offering optimism for economic growth in the spring.
USA – All eyes on the prize
It was all about inflation this week, as January’s CPI beat expectations and markets recalibrated their expectations for rate hikes. Headline inflation accelerated by 0.5 percentage point to 7.5% y/y in January, reaching its highest level in 40 years (Chart 1). Strong consumer demand coupled with pandemic-related supply constraints led to sharp price increases. Core prices also rose significantly from year-ago levels to 6.0% (from 5.5% in December). Price increases were relatively broad-based across the index, with categories such as used motor vehicles (up 40.5%) and gasoline (up 40%) recording some of the the largest increases from a year ago.
Inflation is increasingly a major concern for small businesses. A survey of independent businesses showed that 22% of owners rated inflation as their most important issue in January. This corresponds to the highest level previously recorded in 1981. High input prices, combined with rising labor costs, are reducing the profits of small businesses. In response, 61% of companies said they had already increased their prices. However, fewer companies (a net 47%) plan to do so in the next three months, suggesting companies may be nearing their limit to pass on cost increases to consumers.
Financial markets also reacted to the inflation report as equities fell and 10-year Treasury yields hit 2% for the first time since 2019. These moves came on the expectation that a Persistently high inflation will lead to Fed policy tightening. The market’s implied probability of a rate hike of at least 50 basis points at the March Fed meeting rose to more than 50% after the report, from 24% the previous day, suggesting expectations of a more aggressive tightening.
According to other data, the US trade deficit widened from $79.3 billion in November to $80.7 billion in December. The country hit a record $859.1 billion trade deficit for the full calendar year, a 27% increase from 2020 and surpassing the previous record high of $763.5 billion in 2006 (Chart 2) . For the year, imports increased by 20.5% while exports increased by 18.5%. The notable increase in the trade deficit highlights the strength of the US economy as it rebounds from the pandemic. Consumers, supported by generous fiscal policy, have shifted their spending habits towards goods rather than services during the pandemic, and consumer goods are heavily imported.
As the pandemic enters its third year, governments and citizens are increasingly learning to live with it. Many states, including California, Oregon, New Jersey, Connecticut, Delaware, New York, Illinois, Massachusetts and Rhode Island, have announced that rules requiring masks and/or proof of vaccination will end in March. Local governments and school boards, however, have the discretion to maintain their own requirements.
The announcements are a step towards getting back to normal, even though recently introduced cross-border vaccination mandates for truckers have sparked protests leading to the blockage of the busiest land border crossing between the United States and Canada. The slowdown at the Ambassador Bridge crossing has forced several automakers to halt or slow production due to delays in delivery schedules. As the border reopens and normal traffic resumes, these disruptions should dissipate.
Canada – Reopening plans finalized
This week, bond yields rose, driven by the impending rate hike cycle and an upside surprise on US consumer price inflation. Stocks managed to hold onto their gains on optimism that demand will rebound as public health restrictions are lifted.
First, in good news for the long-term economic outlook, the first estimates from the 2021 Canadian Census were released this week, showing that Canada’s population grew by 5.2% between 2016 and 2021 (1% per year) – a rate that puts it at the top. of the G-7 group. With immigration being the main driver of population growth, most of these gains occurred between 2016 and 2019, before the pandemic led to border closures and a reduction in international arrivals. Indeed, large population centers that rely heavily on newcomers have seen their population growth plummet when the pandemic put an end to international travel. For example, the census metropolitan area of Toronto has seen its population growth slow from 1.4% in 2019/2020 to around 0.2% in 2020/2021. Unsurprisingly, amid public health restrictions, Statistics Canada noted that Toronto and Montreal saw record population outflows to surrounding areas in 2020/2021.
On the trade front, Tuesday’s release of international trade statistics showed that Canada’s trade balance was back in deficit in December (graph 1). Electronic and electrical equipment and parts (+16.2%) and motor vehicles and parts (+5.1%) pushed up imports in the month, partly due to restocking after difficulties in obtaining supplies earlier in the year. Nominal exports, meanwhile, were dragged down by a sharp drop in energy products, as prices fell.
Yet perhaps the most important news this week came from provincial leaders who began announcing plans to roll back public health restrictions. On Wednesday, Alberta ended its vaccination mandates and Saskatchewan is expected to follow on Feb. 14. Prince Edward Island has set February 17 as the start date for its easing, while Quebec will increase seating limits in restaurants this weekend. These measures mark the beginning of the economic reopening which should help stimulate consumer activity. As the services sector reopens, spending will continue to shift away from goods, easing some of the pressures on supply chains that have driven inflation higher.
Indeed, these are the dynamics that Bank of Canada (BoC) Governor Macklem spoke about during his speech to the Canadian Chamber of Commerce on Wednesday. The Bank of Canada estimates that easing supply chain constraints will help bring inflation down to “around 3% by the end of the year.” However, the Bank of Canada’s target inflation rate is 2%, and to achieve price growth the rest of the way, interest rates will rise. As Governor Macklem noted, “a significant shift in monetary policy” is underway.