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Surprisingly durable U.S. economy poses key question: Are we facing higher-for-longer interest rates? – The Globe and Mail

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Federal Reserve Board Chairman Jerome Powell speaks during a news conference in Washington, on July 26.ELIZABETH FRANTZ/Reuters

A year ago, Chair Jerome Powell delivered a stark warning: To fight persistently high inflation, the Federal Reserve would continue to sharply raise interest rates, bringing “some pain” in the form of job losses and weaker economic growth.

Since Powell spoke at last summer’s annual conference of central bankers in Jackson Hole, Wyoming, the Fed has followed through, raising its benchmark rate to 5.4 per cent, its highest level in 22 years. Substantially higher loan rates have followed, making it harder for Americans to afford a home or a car or for businesses to finance expansions.

Yet so far, broadly speaking, not much pain has arrived.

Instead, the economy has powered ahead. Hiring has remained healthy, confounding legions of economists who had forecast that the spike in rates would cause widespread layoffs and a recession. The unemployment rate is near a half-century low. Consumer spending keeps growing at a healthy rate.

As Powell and other central bankers return to Jackson Hole this week, the economy’s resilience has thrust a new set of questions at the Fed: Is its key rate high enough to slow growth and cool inflation? And will it need to keep its rate elevated for longer than expected to slow growth and tame inflation?

“The economy seems to be humming along well, inflation is coming down,” said David Beckworth, a long-time Fed-watcher who is a senior fellow at the Mercatus Center at George Mason University, a think tank. “It seems more and more likely that we’ll have higher growth and higher interest rates going forward.”

One after another, economists have postponed or reversed their earlier forecasts for a U.S. recession. Optimism that the Fed will pull off a difficult “soft landing” – in which it would manage to reduce inflation to its 2 per cent target without causing a steep recession – has risen. Nearly seven in 10 economists polled by the National Association for Business Economics say they’re at least somewhat confident that the Fed will achieve a soft landing, according to the NABE’s latest survey.

On Friday, Powell’s keynote speech at this year’s Jackson Hole conference will be scrutinized for any hints that the Fed intends to keep borrowing rates high for a prolonged period. Wall Street traders, who earlier this year had predicted that the Fed would begin cutting rates by year’s end, now don’t envision any rate cuts until well into 2024.

In the meantime, optimism is rising in financial markets not only for a soft landing but for an acceleration of growth. Last week, the Fed’s Atlanta branch estimated that the economy is growing at a blistering 5.8 per cent annual rate in the current July-September quarter – more than double its pace last quarter. That estimate is likely too high, but it still suggests the economy is likely accelerating from last quarter’s 2.4 per cent rate.

Such expectations have helped fuel a surge in bond yields, notably for the 10-year Treasury note, which heavily influences long-term mortgage rates. The 10-year yield, which was around 3.75 per cent in mid-July, has soared to 4.3 per cent, its highest level in 15 years.

Accordingly, the average fixed rate on a 30-year mortgage has topped 7 per cent, the highest level in 22 years. Auto loans and credit card rates have also shot higher and will likely weaken borrowing and consumer spending, the lifeblood of the economy.

Some economists say those higher long-term rates might lessen the need for further Fed hikes because by slowing growth, they should help cool inflation pressures. Indeed, many economists say they think the Fed’s July rate increase will prove to be its last.

Even if the Fed imposes no further hikes, it may feel compelled to keep its benchmark rate elevated well into future to try to contain inflation. This would introduce a new threat: Keeping interest rates at high levels indefinitely would risk weakening the economy so much as to trigger a downturn.

It could also endanger many banks by reducing the value of bonds they own, a dynamic that helped cause the collapse of Silicon Valley Bank and two other large lenders last spring.

“We’re not totally out of the woods yet, for banks or the economy,” said Raghuram Rajan, an economist at the University of Chicago and former head of India’s central bank.

The jump in Treasury yields has likely been driven, in part, by the government’s ramped-up sale of bonds to finance gaping budget deficits. At the same time, the Fed is no longer buying bonds as it did during and after the pandemic recession to drive down borrowing rates. Many central banks overseas have also stopped or reduced their bond purchases. Banks and some investors are wary, too, given the potential for rates to rise further and reduce the value of their existing bonds.

“Where is the demand for these bonds going to come from?” Rajan asked. Weak demand could force bond yields even higher to try to attract buyers.

Other threats also loom. Some analysts say they think the Fed’s 11 rate hikes have yet to exert their full effect on the economy.

Oscar Munoz, chief U.S. macro strategist at TD Securities, said the Fed’s initial rate increases were merely the equivalent of lifting its foot off the accelerator. By Munoz’s calculations, only since the start of 2023 has the Fed’s benchmark rate been high enough to slow growth. He thinks it could take up to another year for the full impact of the rate increases to be felt.

One reason why economists say the rate hikes haven’t caused more pain is that consumers stockpiled savings after the pandemic struck in 2020, thanks to federal stimulus checks and other aid.

But those savings are dwindling. The Fed’s San Francisco branch estimated last week that pandemic-era household savings have shrunk to just $190-billion – from a peak of $2.1-trillion – and will likely run out entirely by next month.

Though year-over-year inflation has slowed to 3.2 per cent from a peak of 9.1 per cent in June 2022, gas and grocery prices are still elevated compared with two years ago. And items like rent, restaurant meals and other services are still growing more expensive.

“We should be somewhat worried that between exhausting their savings and the purchasing power of their money being eroded by inflation, many people are facing tighter budgets,” said Karen Dynan, a Harvard economist and former chief economist at the Treasury Department.

Still, the longer the economy chugs ahead, the more it suggests that growth is sustainable. It also raises the tantalizing possibility that the post-pandemic economy has shifted to a higher gear and can expand even with elevated borrowing costs. If higher rates were to become deeply rooted in the U.S. economy, it would mark a fundamental change after the many years of ultralow borrowing costs that preceded the pandemic.

“There is a good chance that when things settle down, we’ll be back to a more normal equilibrium, where you have higher interest rates, inflation centred more around 2 per cent instead of below it, wage growth is a bit stronger,” said Kristin Forbes, an economist at MIT and former official at the Bank of England. “Workers have more bargaining power, so we could end up in just a healthier environment all around.”

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Economy

S&P/TSX composite gains almost 100 points, U.S. stock markets also higher

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TORONTO – Strength in the base metal and technology sectors helped Canada’s main stock index gain almost 100 points on Friday, while U.S. stock markets also climbed higher.

The S&P/TSX composite index closed up 93.51 points at 23,568.65.

In New York, the Dow Jones industrial average was up 297.01 points at 41,393.78. The S&P 500 index was up 30.26 points at 5,626.02, while the Nasdaq composite was up 114.30 points at 17,683.98.

The Canadian dollar traded for 73.61 cents US compared with 73.58 cents US on Thursday.

The October crude oil contract was down 32 cents at US$68.65 per barrel and the October natural gas contract was down five cents at US$2.31 per mmBTU.

The December gold contract was up US$30.10 at US$2,610.70 an ounce and the December copper contract was up four cents US$4.24 a pound.

This report by The Canadian Press was first published Sept. 13, 2024.

Companies in this story: (TSX:GSPTSE, TSX:CADUSD)

The Canadian Press. All rights reserved.

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Economy

Statistics Canada reports wholesale sales higher in July

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OTTAWA – Statistics Canada says wholesale sales, excluding petroleum, petroleum products, and other hydrocarbons and excluding oilseed and grain, rose 0.4 per cent to $82.7 billion in July.

The increase came as sales in the miscellaneous subsector gained three per cent to reach $10.5 billion in July, helped by strength in the agriculture supplies industry group, which rose 9.2 per cent.

The food, beverage and tobacco subsector added 1.7 per cent to total $15 billion in July.

The personal and household goods subsector fell 2.5 per cent to $12.1 billion.

In volume terms, overall wholesale sales rose 0.5 per cent in July.

Statistics Canada started including oilseed and grain as well as the petroleum and petroleum products subsector as part of wholesale trade last year, but is excluding the data from monthly analysis until there is enough historical data.

This report by The Canadian Press was first published Sept. 13, 2024.

The Canadian Press. All rights reserved.

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S&P/TSX composite up more than 150 points, U.S. stock markets mixed

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TORONTO – Canada’s main stock index was up more than 150 points in late-morning trading, helped by strength in the base metal and energy sectors, while U.S. stock markets were mixed.

The S&P/TSX composite index was up 172.18 points at 23,383.35.

In New York, the Dow Jones industrial average was down 34.99 points at 40,826.72. The S&P 500 index was up 10.56 points at 5,564.69, while the Nasdaq composite was up 74.84 points at 17,470.37.

The Canadian dollar traded for 73.55 cents US compared with 73.59 cents US on Wednesday.

The October crude oil contract was up $2.00 at US$69.31 per barrel and the October natural gas contract was up five cents at US$2.32 per mmBTU.

The December gold contract was up US$40.00 at US$2,582.40 an ounce and the December copper contract was up six cents at US$4.20 a pound.

This report by The Canadian Press was first published Sept. 12, 2024.

Companies in this story: (TSX:GSPTSE, TSX:CADUSD)

The Canadian Press. All rights reserved.

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