United States Highlights
- The Fed raised the key rate by 50 basis points for the first time since 2000 and signaled that more hikes of the same magnitude were in the pipeline.
- The economy added more jobs than expected in April, but the labor market remains tight, with the number of workers looking for work falling.
- Supply constraints continue to create a mismatch between demand and supply. If supply doesn’t improve, inflation will stay high, making the Fed’s job harder.
- The yield on Canadian 10-year bonds crossed the 3% threshold for the first time since 2011 this week.
- Higher rates are weighing on housing, with early data pointing to sharp declines in April sales in Vancouver, Calgary and Toronto. The latter is now poised to be a buyer’s market.
- Employment growth slowed in April and hours worked declined. However, both are following big gains in Feb/March and some slowing was expected given an economy tapping into excess demand.
United States – Tight corners of the economy
It was a big week for the US economy with a Federal Reserve decision on interest rates and early macro indicators for April. As widely anticipated, the Fed raised the policy rate by 50 basis points for the first time since 2000. Further tightening is on the way: we expect the central bank to raise the fed funds rate in two more moves of 50 basis points base at its next two meetings. At this point, we expect it to revert to more gradual quarter-point adjustments (see Dollars & Sense). Chairman Powell’s reaction against the possibility of a bigger rise was initially accepted as bullish by the equity market, but sentiment quickly reversed, pushing the equity market down a quarter of a percent. and bond yields down 15 basis points for the week (at time of writing).
This morning’s jobs report surprised with 428,000 jobs added in February, according to the payrolls survey, well above the 380,000 predicted by forecasters. The unemployment rate, measured by the household survey, remained at 3.6%. The labor force – a measure of people working or actively seeking work – fell unexpectedly, sending the participation rate down to 62.2%. As a result, an already large deficit relative to the pre-pandemic trend has widened further (Chart 1). Without progress on this front, the labor market will remain very tight, bringing little relief to companies already struggling to attract workers.
At the same time, leading economic indicators – the ISM Purchasing Managers’ Indexes – were weaker than consensus expected, while remaining in expansionary territory. The manufacturing sector decelerated for the second consecutive month. All major sub-components except the supplier shipments index fell, with the biggest drop being the employment index. Weak demand is in line with our expectation that consumers will begin to reduce their purchases of manufactured goods in favor of services. In this context, a deceleration in the services sector was somewhat disappointing. The underlying details suggest that current business activity has picked up, but new orders and new export orders have fallen. Another drag was the employment sub-index, which fell back into contractionary territory, likely due to “hypercompetitive” demand for workers, as one of the purchasing managers suggested.
Importantly, supply constraints and logistical challenges continue to create a mismatch between demand and supply in both sectors of the economy. Relative to history, the Supplier Delivery Index has been exceptionally strong since March 2021, creating a gap between this subcomponent and the rest of the drivers in the index (Chart 2). Another way of thinking is that delivery times remain atypically slow relative to weaker demand.
If supply fails to improve in parallel with the slowdown in demand, inflation should remain elevated. This will make it harder for the Fed to slow growth without crushing the economy into a recession. The good news is that strong consumer finances point to a slowdown in spending rather than an outright pullback. This should help the Fed pull the economy out of its predicament.
Canada – Higher Rates Do Their Job
For the housing market, the most important yield is the Canadian 5-year, which drives the prices of many mortgage products and is near 24-year highs. And, with the Bank of Canada raising its key rate, variable rate mortgage rates are also on the rise. This means there is nowhere for potential buyers to run, nowhere to hide. Affordability is rapidly eroding and housing demand is weakening.
This week brought further evidence that the housing market correction intensified in April (Chart 1). Home sales fell month-over-month in Calgary and Vancouver, but fell nearly 30% in one month in Toronto. The latter region appears to be the real exception here, as supply and demand conditions are now more favorable to buyers, and average prices are down 6.4% over the month. On the other hand, markets remained quite tight in Calgary and Vancouver and price growth seems to have been stronger. It’s no surprise that the Toronto market is correcting more than these other jurisdictions – it’s the other side of the rapidly rising price that has made Toronto the most expensive market in all of Canada in recent months.
Of course, the Bank of Canada is not done raising rates. Our updated forecast calls for the central bank to raise its key rate to 2% in a very short time before switching to a more gradual pace of rate hikes, eventually ending the year at 2.5%. This means further downward pressure on Canadian home sales and prices.
As the interest-rate-sensitive housing sector weakens under the weight of higher rates, the overall economy also appears to have taken a breather last month. This morning’s jobs report showed employment rose 0.1%m/m (or 15,000 jobs), but hours worked fell 1.9%m/m. Other details were weak as full-time employment fell. However, the more modest job gain follows the massive addition of 409,000 jobs in February and March, and the drop in hours worked only partially reflects the significant gains made during these two months (graph 2). In addition, part of the decrease was due to absences related to COVID-19. Moreover, the job growth of 15,000 is only slightly below the long-term average and was achieved against the backdrop of an economy operating in excess demand.
While the drop in hours worked throws some cold water on the Bank’s forecast of 6% annualized GDP growth in Q2, the jobs report is not going to deflect the Bank from its trajectory of tightening. Expect a 50 basis point move in June.