Canada’s economy shed an unexpected, outsized number of jobs in August for the third consecutive month, another indication that growth is slowing as the Bank of Canada attempts to deliver a soft landing while wrestling exceptionally high inflation down to more normal levels.
The country lost 40,000 jobs last month while the unemployment rate rose to 5.4 per cent, Statistics Canada reported on Sept. 9.
The consecutive losses over the past three months amount to 114,000, marking the first period in the pandemic of declines unrelated to lockdowns and restrictions. It’s also a phenomenon that historically does not occur outside of a recession, Desjardins head of macro strategy Royce Mendes noted.
“While revisions can always change the picture down the road, the deterioration in the job market appears to be occurring faster than anticipated,” Mendes wrote in a client note.
The job losses were mostly concentrated in the public sector, particularly education, which lost 50,000 jobs. Some of those drops in schools and educational institutions could reverse when data for September comes out, reflecting the back-to-school season. The public sector has borne the brunt of the jobs decline over the summer, losing 79,000 positions of the 114,000 overall in the past three months. But, it could be overstating broader weakness since it reflects a reversal in the hiring surge during the pandemic, Stephen Brown, senior economist at Capital Economics, said in a note.
Economists pinned the previous declines in June and July on growing retirements and job seasonality, but those arguments “are no longer as convincing,” Brown wrote.
Higher interest rates cooled housing markets almost immediately and building permits declined in July, showing just how sensitive Canada’s real estate sector is to the central bank’s moves. “Higher interest rates mean projects get canceled as developers cannot secure financing and buyers hold back,” Tu Nguyen, economist at accounting and consultancy firm RSM Canada, said.
The rise in the unemployment rate was the first in seven months and the first that didn’t coincide with pandemic lockdowns or restrictions. In June, the unemployment rate dropped below five per cent to 4.9 per cent, the lowest rate on record, and held steady in July, despite job losses. Employment declines and labour force growth, up by 66,000, contributed to the half-percentage-point increase, which is still in a range that some economists deem as full employment — that is, anyone who wants a job either has it or can get it.
Despite a rise in the unemployment rate, which would naturally lead to a decrease in pay, average hourly wages were up 5.4 per cent last month from August 2021 compared to 5.2 per cent year over year in June and July. That should catch the eye of policymakers at the Bank of Canada, who are trying to prevent high inflation expectations from becoming entrenched in the economy. If people think prices will continue to rise, they will demand raises, which can lead to businesses increasing sticker prices — a cycle governor Tiff Macklem has said he is trying to curb.
The number of hours worked were also unchanged in August, adding to inflationary worries. “The longer term trend in wage growth confirms the impression that the job market remains very tight. Add in poor productivity growth and the combination of the two is disconcerting if the aim is to get the cost of living under control,” Derek Holt, head of capital markets economics at Bank of Nova Scotia, wrote in a note.
August’s data could fuel worries over the economy’s slowing growth and the possibility of a recession. Typically, it can take a few quarters before the effects of higher interest rates are felt throughout the economy, but the jobs report is another signal that it may be happening sooner than expected. Gross domestic product lost momentum in the second quarter, rising 3.3 per cent when policymakers expected four-per-cent growth and economists expected 4.4-per-cent growth, for example.
“There is no debating that conditions are cooling quickly, with the pullback in construction a clear indication that rate hikes are beginning to bite,” Douglas Porter, chief economist at Bank of Montreal, wrote in a note.
“That cooling fits neatly with the view that the Bank of Canada will further moderate the pace of hikes and may indeed be getting close to the peak (we see another 50 bps of total rate hikes from here). However, the steady upward grind in wage growth and the stability in overall hours worked suggest that the bank won’t back down anytime soon,” Porter said.
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Tiff Macklem said in a speech Thursday to the Halifax Chamber of Commerce that even as inflationary pressures beyond Canada’s border such as high global shipping rates and supply chain concerns subside, domestic sources of price growth such as demand for services remain too hot.
The annual rate of inflation clocked in at 7.0 per cent in August as gasoline costs continued to fall, per Statistics Canada, though prices on food continued to surge, hitting a 41-year high.
Macklem also said surging demand for travel and recreation after the end of COVID-19 restrictions fuelled inflation.
Those forces have helped keep the Bank of Canada’s core metrics of inflation hot even as the headline figure from Statistics Canada has slowed in two consecutive months.
“When combined with still-elevated near-term inflation expectations, the clear implication is that further interest rate increases are warranted. Simply put, there is more to be done,” Macklem said Thursday.
The Bank of Canada, as an institution, and Macklem specifically have been targets in recent months for federal Conservative leader Pierre Poilievre, who charges the central bank with enabling the Liberal government agenda and contributing to rampant inflation.
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During his leadership campaign, Poilievre said he would fire Macklem from his post if he became prime minister, a proposal that has received backlash in turn as not respecting the independence of the institution.
Global National anchor Dawna Friesen asked Macklem in an interview following his speech on Thursday about his response to the Conservative leader.
The governor told Friesen that the central bank’s independence is the reason it’s able to “deliver price stability” and control inflation — a task he was resolute in his comments Thursday the Bank of Canada would be able to accomplish.
“I can tell you, I go to work every day, that’s my focus. Inflation is hurting Canadians. The best way to protect Canadians from high inflation is to eliminate it.”
How high will interest rates go?
The Bank of Canada’s policy rate currently sits at 3.25 per cent, following an increase of 0.75 percentage points on Sept. 7.
The central bank’s benchmark rate has jumped up three percentage points across five consecutive hikes since March, which Macklem acknowledged Thursday is “one of the steepest and fastest tightening cycles we’ve ever conducted.”
CIBC chief economist Avery Shenfeld said in a note to clients Thursday that Macklem’s speech “had a fairly hawkish tilt,” implying a more aggressive stance on monetary policy.
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The central bank had signalled back in September that more interest rate hikes would be needed to tame inflation. But Shenfeld said Macklem’s remarks meant the next rate decision on Oct. 26 was “still a lock” for an increase of half a percentage point with a pause afterwards unlikely.
Warren Lovely and Taylor Schleich of National Bank Financial (NBF) said in a note that they also expect a move greater than the standard 25-basis-point step later this month, with the policy rate ending the year “at no less than” four per cent.
The NBF economists said that Macklem’s tone was reminiscent of recent speeches from U.S. Federal Reserve chair Jerome Powell, who has promised more “pain” to come in efforts to tame inflation south of the border.
Indeed, Macklem was adamant that as the labour market remains tight and wages are beginning to grow, Canada’s economic growth must slow to give supply time to catch up with pent-up consumer demand.
“This will help relieve price pressures here in Canada,” he said.
Weak Canadian dollar fuelling inflation
Asked whether he still believed Canada will skirt a recession, Macklem maintained it is possible to avoid the economic downturn but conceded there are many factors that could complicate those efforts.
Global supply chain issues persist with pandemic-related lockdowns in China, war continues in Europe and inflation could prove “sticky” at home, he cited as ongoing issues the bank is monitoring.
“There is a path to a soft landing but it is a narrow path and there are risks,” he said.
Will Canada see a recession by the end of 2022?
“How high interest rates need to go … really depends on how inflation and the economy responds.”
One such inflationary pressure is the relative weakness of the Canadian dollar to the U.S. greenback.
Usually when a country’s central bank raises interest rates, the national currency gets a boost as investors are incentivized to hold that denomination.
But the Canadian loonie — like most currencies around the world, in fact — has faltered as of late due to the overwhelming strength of the U.S. dollar. The Canadian dollar is at a more-than two-year low of 73 cents to the U.S. dollar as of Thursday.
That’s driving up the prices of imports from the U.S. and weakening the purchase power of Canadians who travel south for the winter, contributing to inflation.
Macklem said Thursday that the lagging loonie means “there’s going to be more to do on interest rates.”
Weighing the wage question
In his speech Thursday, Macklem continued to try to set expectations for inflation in the near- and long-term, pledging the central bank would fulfill its mandate to bring price growth back to its two-per-cent target.
Speaking from Halifax, he alluded to the rebuilding efforts underway following the devastation from storm Fiona as providing resolve for the Bank of Canada’s own campaign.
“Atlantic Canadians will rebuild after this storm as they always have. And the Bank of Canada will control inflation as it has for the last 30 years. We are resolute in our commitment to restore price stability for all Canadians,” he said.
Inflation expectations are a critical part of the fight against inflation itself. When consumer and employer expectations for inflation become “unanchored,” they begin demanding higher wages to offset the impact, which then feeds back into prices themselves as businesses pass on costs to the end-user.
The “wage-price spiral” is a worst-case scenario for the Bank of Canada, Macklem explained, and would require much higher interest rates to tame.
“Once you get into a wage-price spiral, it’s too late,” he said.
But as Macklem has preached this to business leaders and warned them against raising wages too high amid the inflation fight, some have accused the central bank governor of overstepping his bounds and disrupting collective bargaining.
When the governor spoke to the Canadian Federation of Independent Business (CFIB) in July, he warned attendees not to bake today’s inflation levels into long-term wage contracts.
The Canadian Labour Congress has taken issue with this tact — president Bea Bruske said in a statement last month that she’s “deeply concerned about the Bank’s preoccupation with encouraging companies to push down wages, at a time when so many workers struggle to make ends meet.”
Macklem was asked about his wage messaging on Thursday. He maintained that he is leaving decisions about payroll up to businesses, and to workers to decide what wages they are willing to accept.
But he said his guidance has been to not bake high levels of inflation into long-term discussions about salary.
“What I’ve been telling workers, what I’ve been telling businesses, is as you take your decisions, don’t count on inflation staying where it is,” he said.
“Inflation is coming down, and workers and businesses can count on that.”
— with files from Reuters
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OPEC Output Cut Sends A Clear Message To The Market
- OPEC+ on Wednesday decided to cut the output quota by 2 million bpd.
- Heightened volatility in oil markets has been one of the key reasons for OPEC+ to cut output.
- A second reason behind the cut is the need to improve the spare capacity of some of the key oil producing nations.
- U.S. refinery utilization rates have been unusually strong this year.
On Wednesday 5th October, OPEC+, at its 45th Joint Ministerial Monitoring Committee meeting held in Vienna, agreed to cut daily oil production by 2 million barrels per day. As it was the first in-person ministerial meeting for OPEC+ since March 2020, which itself signaled that a major announcement was looming, it was fitting that the group announced the biggest oil production cut since the start of the Covid pandemic. The size of the cut, equivalent to around 2% of global daily oil production, was significantly larger than the expected figure of 1 million bpd. However, according to Reuters, as several OPEC+ member states fell short of their target production levels in August, the real cut is estimated to be less than 1 million barrels per day. Given the magnitude of this step, it is worth looking into the role the group plays in the global oil market and how this latest production cut might affect prices.
The Organization of the Petroleum Exporting Countries, or OPEC, was founded in 1960 and consists of 13 members which account for around 82% of global oil reserves and 30% of oil production. While neither the US nor Russia is part of the group, the latter is part of OPEC+, a wider association that includes 10 non-OPEC countries with shared interests in the oil market. The group, unofficially led by Saudi Arabia, sets production targets for its member countries which influence the global supply of oil, although its targets are not always met by all members. While there are other influencing factors on both the supply and demand side, OPEC+ does exercise a significant influence on the supply and therefore the price of crude oil.
OPEC has been accused on many occasions of behaving like a cartel, unnecessarily restricting supply in order to maintain high revenues from oil exports. The group denies this; OPEC’s secretary general Mohammad Barkindo stated earlier this year that the organisation had “no control” over the spike in oil prices following Russia’s invasion of Ukraine. However, it remains true that due to the proportional significance of oil revenues to OPEC members’ economies, the group certainly benefits from high oil prices.
Incentives to Intervene
In the past few months, there has been notable price volatility in the oil market, though the overall trend has been bearish since the Q2 peak of $123.58 per barrel on June 8th as shown in the graph above. In the past 10 days, oil prices have been hovering between $84 and $90 per barrel and the threat of oil’s value slipping even further is a key reason behind the decision taken by OPEC+.
A second reason behind the cut is the need to improve the spare capacity of some of the key oil producing nations, particularly Saudi Arabia. With the looming threat of a US-led price cap being imposed on Russian oil exports, the expectation is that supply may become even tighter, at which point Saudi Arabia would then increase production once again to take advantage of higher prices. In cutting production ahead of any price cap being introduced on Russian oil, OPEC+ is also sending a strong message to the US that buyers will not dictate oil prices.
Russia also has much to gain from higher oil prices. Due to the sanctions imposed on the nation following its invasion of Ukraine, the buying market into which Russia can sell its oil has been reduced to a few remaining participants. Furthermore, Russia and Saudi Arabia arguably have more to gain from high oil prices than anywhere else; the nations are the third and second largest producers of oil, only behind the US, yet their energy revenues are more proportionally more significant than in the diversified economy of the United States.
The movement towards an alliance between Riyadh and Moscow will frustrate the United States. Earlier this year, President Biden travelled to Saudi Arabia ostensibly to negotiate commitments to greater oil production from the nation. The trip was particularly significant given Biden’s criticism of Crown Prince Mohammed bin Salman, in relation to his alleged connection to the murder of journalist Jamal Khashoggi. This latest announcement from OPEC+ casts Biden’s trip to Riyadh in an unfavourable light, and adds pressure to his administration in the run-up to the nation’s midterm elections in November.
Record Refinery Margins
While the oil market headlines will initially be dominated by OPEC+ announcements, another part of the industry that will come under examination in the coming months is the refinery sector. Refinery utilisation rates have been unusually strong this year and, as noted by Reuters, could remain above 90% in the US for a third consecutive quarter in Q4 2022. The US has particularly maximised its refinery capacity due to pressure on the industry from the Biden administration to lower domestic gasoil and diesel prices as the midterms loom.
Elsewhere in the world, refineries have also been run at high levels for two reasons. The first is due to the capacity that was lost as plants were forced to close during the Covid pandemic, meaning there is now a lesser total amount of global crude oil refining capacity. The second, more significant, reason is that margins for refiners have ballooned to record levels this year. This issue was explained by Erwin Seba for Reuters: “the margin from selling diesel from a barrel of oil and replacing that barrel, called the diesel crack spread, this week [26/09/22 – 02/10/22] was about $54 per barrel on the Gulf Coast, compared to about $12 a year ago, according to Refinitiv.” This level of profiteering within the refinery industry may come under closer inspection if global oil prices rally back north of the $100 per barrel mark.
Back in August, Saudi Arabian Energy Minister Prince Abdulaziz bin Salman cited “extreme” volatility as a key reason why OPEC might need to step in and protect the integrity of the oil market. Wednesday’s announcement of a production cut of 2 million barrels per day is unlikely to instantly relieve the oil market of the price volatility seen during 2022, but it may alter the wider trajectory of oil prices to point higher once again. It remains to be seen whether the Energy Minister will remain as concerned about market volatility if prices rise above $100.
By ChAI Predict
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