U.S. Highlights
- The U.S. labor market continues to impress – churning out jobs like nobody’s business (+250k), keeping the unemployment rate near record lows (3.7%), drawing people into the labor force (participation rate up +0.2 percentage points), and pushing up wages to boot (3.1% year-on-year – the highest since 2009)
- The fly in the ointment? A fierce sell off in equity markets in October, putting in question the more than nine-year-old stock bull market. Major stock indices closed the month down, eking out only marginal gains year-to-date.
- Trade tension with China is one catalyst for market jitters. A phone call between Presidents Xi and Trump this week signals progress, but the jury is still out on whether a broader trade war can be avoided.
Canadian Highlights
- The Canadian economy eked out a gain in August despite not firing on all cylinders. A recovery in oil and gas drove a 0.1% month-on-month rise in activity.
- Both September trade data and October’s job figures were soft. As a result, we are currently tracking Q3 growth at a roughly trend pace of 1.8% (Q/Q, annualized).
- Overall, this week’s data suggests a December rate hike is unlikely. With data dependency the guiding principle, the evolution of wage growth and household borrowing will be key triggers for the next move.
In a job market that just won’t quit, U.S. workers are finally hitting pay dirt. Job growth shows little sign of slowing with nonfarm employment growing by 250k in October. The labor force participation rate also edged up to 62.9% and the unemployment rate continued at its cycle low of 3.7% – the lowest since 1969. With workers getting scarcer, companies either have to pay up, or scale down expectations.
The tight labor market is indeed forcing many to compete for workers by boosting paychecks. Both the employment cost index, which captures wages and benefits, as well as average hourly earnings show upticks in workers’ compensation. Wages broke through the 3% growth ceiling that has stood for nearly a decade, coming in at 3.1% y/y. Wages haven’t exceeded 3% growth since April 2009 (Chart 1).
Going in the opposite direction, home-price gains decelerated for the fifth consecutive month in August. The S&P Case-Shiller Home Price Index grew 5.8% y/y, falling below 6% for the first time in a year. After more than five years of solid home price growth, this is the latest indication of a slowdown in the housing market, which is likely to persist as interest rates edge higher. Despite slowing, house price inflation remains well above wage growth, contributing to the affordability crunch prospective buyers have grappled with of late (Chart 2).
Rounding out the week were data on ISM manufacturing and personal income and spending. Manufacturing activity eased in October, though it remained in growth territory as manufacturers continued to struggle with capacity constraints and tariff pressures. Though consumer spending momentum remained strong through the end of Q3 and should result in a solid Q4 handoff, the stimulus from tax cuts likely plateaued in Q3 and could be a harbinger of slower consumer spending. Year-on-year, core PCE inflation remained at 2.0% for a fifth straight month.
One potential development that could raise inflation (and further reduce the stimulative impact of tax cuts) are higher tariffs. On that front, tensions with China continue to simmer. This week, the Commerce Department barred U.S. companies from engaging in business with a state-owned Chinese chip maker after it was accused of stealing trade secrets from an American firm. The news left China’s chip industry on edge, feeling vulnerable to the escalating China-U.S. trade standoff. Subsequently, a spark of hope emerged Thursday when President Trump signaled progress on trade talks. This followed a phone call, initiated by the White House, to President Xi. The two countries are now more likely to resume talks at the G-20 summit in Buenos Aires later this month. As things stand, however, the jury is still out on whether there will be a cease fire in the trade fight following the summit.
All told, the U.S. economy is currently enjoying the sweet-spot of low inflation and unemployment. Only time will tell for how long.
This was a fairly full week for data, and the signals sent were less than encouraging. In the positive column was monthly GDP data, revealing an economy that eked out a seventh straight monthly gain in August (Chart 1). The term ‘eked’ definitely applies, as only 8 of 20 major industries grew, with a recovery in the oil and gas sector doing yeoman’s work to keep growth positive.
Looking to September, the international trade data was soft. Exports and imports fell in both nominal and volume terms, and the modest trade surplus initially reported for August got revised into a deficit. For the quarter as a whole, goods exports failed to get into gear (Chart 2), with many categories underperforming.
Moving one month ahead, October’s job data had a positive headline, as the unemployment rate fell to 5.8%, but the details were soft. Job gains were down to self-employment, not negative in itself, but not encouraging either. Most discouraging was a decline in wage growth for a fifth straight month. At 1.9%, wage growth for permanent employees is now below even core inflation.
Income growth will be even more important going forward. The Bank of Canada has indicated its desire to bring its policy rate back to its ‘neutral’ range of 2.50% to 3.50%. Getting from here to there is no easy task. As discussed in our latest report, rate hikes over the past year or so have already begun to bite, driving credit growth to its slowest pace since the 1980s. With elevated debt levels, servicing costs are beginning to eat up a bigger share of household budgets. This leaves less money than otherwise for spending, putting a damper on consumption growth going forward.
All of this is by design, and a modest deleveraging that sees household income growth outpace debt can only be a good thing in the long term. But this won’t be easy– too much slowing of spending will sap overall economic growth, while too little credit moderation leaves the risks around household finances unaddressed at best.
There are two barometers that we will be watching closely in assessing the Bank’s likely path forward. The first is credit growth, where a dramatic slowing would be a warning sign that rate hikes are already having a sizeable impact, implying a slower path of tightening. As it stands, we see no reason to panic in the latest figures, with month/month accelerations suggesting higher interest rates are not overly crimping demand. The second is wage growth – strength in wages would suggest that the economy is indeed at or exceeding capacity, and so more rate hikes are needed. Today’s data was disappointing, but other measures, notably payrolls, paint a more positive picture. With near-term developments largely in line with Bank of Canada expectations, we see no reason to accelerate the pace of hikes. However, as data dependence is the watchword for the Bank of Canada, making every decision ‘live’ – a positive surprise could change the calculus very quickly. Watch this space.
FOMC Rate Decision
Release Date: November 8, 2018
Previous: 2.25%
TD Forecast: 2.25%
Consensus: 2.25%
The November FOMC meeting should pass without much market impact, as the Fed should remain on track for another hike in December but should not signal any change in policy. The risk is for a modest dovish market interpretation from mark-to-market edits to the description of recent data in the statement. There is a small chance that the Committee will release information about its balance sheet deliberations, suggesting an earlier end to runoff than previously indicated. That would likely generate a more dovish market response.
Canadian Housing Starts – October*
Release Date: November 8, 2018
Previous: 189k
TD Forecast: 193k
Consensus: NA
Housing starts are projected to post a modest recovery to a 193k pace in October. We look for stronger multi-unit start to drive the pickup following declines in 6 of the last 7 months, while single family starts should remain under pressure amid a trend towards smaller homes. We see scope for single family starts to give up all of their 1.9% increase from September which would leave construction activity at its weakest pace since 2009. This fits with the wider rotation in growth away from consumption and housing, although we would note that nonresidential construction has helped offset weakness in the latter over Q3.
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