After eight consecutive rate hikes, the Bank of Canada is widely expected to stick by its pledge to hold steady. But questions remain about the direction of inflation and employment. Greg Bonnell speaks with Derek Burleton, Deputy Chief Economist at TD, about the central bank’s next move.
* The Bank of Canada meets this week, widely expected to keep rates on hold at 4.5%. This would be the first pause after the central bank hiked rates a total of eight times over the past year.
So where are we in this economic cycle, and what can we expect in the year ahead? Derek Burleton is Deputy Chief Economist at TD and joins us now.
Derek, great to have you back on the show.
* Thank you, Greg. Great to be here.
* So let's talk about the Bank of Canada. Last time we heard from them, they said they were going to be on a pause. Now they can either prove or disprove that pause. It was a conditional one. So what's the economy telling us, and what do you think is going to play out for the Bank of Canada?
* Well, conditional pause, that was only six weeks ago they went onto a conditional pause. Really only a month of data, not enough really. Essentially the signaling that they had six weeks ago was, as long as the economic indicators line up with their forecast, and one where inflation slows steadily, job markets, importantly, start to slacken, and general economic growth starts to slow, then they'll maintain that pause. No talk about rate cuts at this stage or anything like that.
So here we are six weeks later. We've had January data. They proved to be quite strong, employment in particular, but the inflation numbers came in under their expectations. So consider that a bit of a wash. But I think in any event, Greg, it's just-- after such a short period of time, it would be a little odd for Bank of Canada to commit to one thing, even though it is conditional, and then all of a sudden move one way or another.
I think really what they're doing is punting down the big decisions to future meetings this spring and even into the summer.
* That'd be a very strange pause, to say, well, we paused between meetings, like that's what you usually do anyway. So that does make a lot of sense.
Talk about that labor market, though. Because we were warned, either from the Bank of Canada or from the Fed, that, from all these aggressive rate hikes, they were expecting to see pain in the economy, expecting to see pain in the labor market. We're not getting that pain. Is that making much sense at this stage?
* No. In fact, that's a great way to characterize it. The word "anomaly" comes to mind. But I just say, the data aren't making a whole lot of sense. I mean, look at the explosion in employment growth we've had. For an economy that's growing but not very quickly, I mean, "resilience," I think, is a good word to describe it.
Rate hikes, as you mentioned, one would have thought they would have started to bear down more than they have on hiring and the like. We've seen some turn in vacancies out there. And I think that's kind of the leading indicator, the first step.
But yeah, I've been blown away. And I think we look at the January data, and one can make a similar argument in the US. January is a tough month to adjust for seasonally with weather shifts. Pandemic, I think, has distorted some of these adjustments. And I think the Bank of Canada is going to be feeling the same way. They're probably discounting some of the recent strength, given some of the other data indicators they're looking at. They'll want to give it a little time to see that employment begin to cool.
But really, to keep rates on pause, it's more than just a bit of a February reversal that we might see this Friday. It's for a number of months to show slack building in the labor market and for wage growth to begin to come down a bit.
* Yeah, with jobs Friday coming up, obviously it's going be important on both sides of the border. Does that give us some sort of comfort then that we might skirt a punishing recession, if the economy has been able to hold up to the degree that it has in the face of these higher borrowing costs? Do we do we sort of not get off Scot-free but sort of get off the worst case scenario?
* Yeah, I think so. And that's been our narrative for quite some time, even despite the strength we've seen of late. I think we were counting on some of these offsetting mitigating factors to cushion some of the downturn, excess savings of households. Labor market, where demographics are playing an effect, I do think companies will be a little bit careful announcing layoffs. They'll probably cancel some of their job postings before they lay off workers in any kind of huge, substantive amounts. So that's been our narrative.
Now, the challenge is if job market doesn't slow more noticeably soon, then the Bank of Canada may have to move off that pause. And the extent they hike rates into the second half of this year, I think it could lead to a 2024 which is more uncertain about recession. And really, that's where I think the balance of risk will shift to.
* It's interesting, because this conditional pause puts us on a different path than the US Federal Reserve, which is also looking at a very strong labor market, but the full expectation that we're going to get further hikes. So how do we explain this difference? Is it simply that the BoC took a look around at some of the underpinnings of our economy and got a little bit concerned maybe about our debt?
* Yeah, they did. And I think they've made-- I know Macklem has spoken about the debt in public appearances and the like. I think that's really a differentiating factor between Canada and the United States. In fact, household debt is high in Canada. In the US, it's not as big an issue.
I still think on both sides of the border they are wondering, seriously wondering, if we don't start to see data slow, that the rate hikes aren't having their anticipated impact. And in Canada, what's interesting, just to shift it back here for a second, those fourth quarter GDP numbers we had last week for Canada-- if you look at consumer spending, but more importantly look at the income side, incomes exploded in the fourth quarter. And a lot of that was transfer payments. Wages and salaries were strong. There was a 60% increase in government transfers to households, national daycare subsidy, GST rebates, you name it. There were inflation relief packages.
And I think that's something that really could tip the Bank of Canada ultimately to have to hike further. Because as we go through budget season, there could be more relief measures. We saw it in BC last week. And I don't know if this has been fully factored into the Bank of Canada calculus yet, but it is something that I'm going to be watching in the coming days and weeks.
* Yeah, at some point the potential for fiscal policy to start undoing monetary policy, at least where they hope to be.
Let's talk about the Fed. Because the central bank, our central bank, the Bank of Canada, not the only show in town, because we've got Jerome Powell testifying to lawmakers over two days. I never know how to approach these congressional testimonies in the sense that, are we really going to hear anything that we haven't already heard from the central bank, unless they want to send a new message to the market. How do we read this one?
* Yeah, and I think that's a good point. I think unless he chooses to send a message to the market-- my guess is that's not his nature. I think he likes to leave it up to the committee. And that will be next week, on the 22nd, we get the next rate decision. I don't think he's going to say a lot other than generalizations that they may have to leave rates higher for longer. And that's really been a message echoed out of other central banks.
But you never know. I mean, the data have been strong. Inflation, unlike Canada, perked up a bit in January, more than expected. So when he looks at the balance of data, he may decide to just kind of push that-- either the notion that 50 basis points is something they're going to be carefully looking at. Right now, the market's only factored in about a 25% odds of a 50 hike next week out of the States. Or it could be the terminal rate, in other words, that peak interest rate. Maybe he wants to push more of the envelope on that. But I don't see it. Maybe something will come up in the questioning that will interest the market.
But I think, to bring back that point about divergence in policy-- and I think this is something that the Canadian dollar, we're going to have to watch-- markets right now are already pricing in about a 70-basis point divergence in peak interest rates in Canada. And in the US and Canada, they don't have a full 1/4 point hike addition. They've got a little bit of rate increases vis a vis current levels by the summer.
But yet the Canadian dollar is not weakening too much. And I think, for those that kind of question, can we run divergent paths, I think the market-- so far, so good. I'm not saying it won't turn. But that, to me, isn't a real risk factor for Canada raising rates. I think it's more consumer spending resilience and the job markets to watch.
* Big week. And then we're going to round it out, as we've said, with jobs on Friday. Any sense of what we might see from both economies?
* Yeah, I mean, it's a bit of a lottery these days. We tend to understate. I think when I look at consensus, I'm OK with it. US, 200,000 payrolls, which would be a big step down from January. But 200,000 is still strong. So I think the markets will still view that, maybe push the probability a bit more to a 50-basis point hike. And Canada, 0 is essentially what we're looking at after the two-month explosion in jobs. That would still leave a fairly healthy trend. And Bank of Canada will want to see more of that. That's for sure.