Monthly economic webcast

Here is our monthly economic webcast for October, entitled “Rate cuts support soft landing.” Since it was first published, our soft-landing odds have risen even further, as discussed shortly.

Hurricane distortions

The U.S. southeast was struck by not one but two major hurricanes over the past several weeks: Helene and Milton. As always, natural disasters constitute human tragedies foremost, but they also bring short-term economic effects.

North Carolina suffered the most damage from Hurricane Helene, while Florida was the primary target of Hurricane Milton. Both regions experienced a significant decline in economic output while electricity was out and as debris was cleared. A reasonable approximation is that overall U.S. gross domestic product (GDP) may have grown by an annualized 0.25 to 0.5 percentage points less quickly in the affected quarter. This is a visible sum, but not a dominant force.

Note that the timing of the hurricanes is awkward from an accounting perspective, straddling the very end of the third quarter and the very start of the fourth quarter. The economic dip should thus be spread across the two quarters, if skewed somewhat toward the fourth quarter given the timing of the data collection for certain surveys.

Recall that the majority of any hurricane-induced decline in economic output is temporary, with the result that growth in the subsequent month and quarter should be slightly faster as a return to normalcy is achieved.

From a monthly data perspective, the majority of the damage should be visible in the October data, also due in part to the timing of survey collection. The average historical hurricane month has experienced about 50,000 fewer U.S. payroll jobs created than normal, jobless claims have risen by around 20,000 and housing starts have fallen by around 4%.

Recall that the majority of any hurricane-induced decline in economic output is temporary, with the result that growth in the subsequent month and quarter should be slightly faster as a return to normalcy is achieved. The November data should be somewhat stronger as any weakness is unwound. We must then wait until December for a clean reading on the data, which won’t be released until January. As a result, assessing the state of the U.S. economy is going to become somewhat more difficult for the remainder of the year.

Over the medium and long run, the need to rebuild damaged property and infrastructure should provide a small boost as additional capital expenditures occur, with this additional activity spread over a number of years. Estimates of the damage done by the hurricanes – and so what will theoretically need to be reconstructed – amount to several hundred billion dollars.

Any effect on inflation should be quite small but would theoretically have a positive sign due to shortages and supply-chain headaches. It is unlikely that monetary policy deviates from its intended course in response to a temporary shock like a hurricane. Finally, as discussed in a later section, the hurricanes could have an effect on the U.S. presidential election.

Falling recession risk

We continue to incrementally scale back the likelihood of a U.S. recession over the next year, this time from a 30% chance to a 25% chance.

That is still materially higher than the baseline 10—15% risk associated with the average year, with this gap informed significantly by still-high interest rates and a variety of recession signals that continue to blink red, such as inverted yield curves and an unemployment rate that has increased off its floor.

But the new, reduced probability nevertheless constitutes progress, with a soft landing coming not just into view, but gaining firmer footing.

Importantly, U.S. economic data has suddenly pivoted from serially disappointing expectations as it did over much of 2024 to recently exceeding them (see next chart).

Economic surprises have started to rebound

As of 10/03/2024. Sources: Citigroup, Bloomberg, RBC GAM

The U.S. job numbers for September were also an important milestone. Both the payrolls and household survey suggest an acceleration in hiring in recent months (see next chart).

U.S. hiring rises according to two surveys

As of September 2024. Sources: U.S. Bureau of Labor Statistics (BLS), Macrobond, RBC GAM

The 254,000 new jobs recorded by the payrolls survey was particularly notable, not just because it is consistent with a healthy economy and exceeded expectations by more than 100,000 positions, but because there were a further 72,000 jobs added via positive revisions to earlier months. This is worth more than it looks because the prior trend had been one of consistently negative revisions, so this is quite a large positive surprise relative to the default assumption that those downward revisions would continue.

The revisions also significantly refashion the prior few months. As opposed to a job market steadily shedding jobs and drifting below the 100,000 jobs per month threshold, the 3-month moving average is now an eminently robust +186,000 per month. This is not much less than the 203,000 new monthly jobs averaged over the past year. The weak job numbers from August now appear to have been an outlier rather than the ominous start of a new trend.

With an unemployment rate that has now fallen in each of the past two months (down to 4.1% from a 4.3% peak), the earlier regular slippage in the unemployment rate has at least temporarily been halted. While the Sahm Rule has already been triggered (meaning that a recession usually happens after the unemployment rate has increased off its low by as much as it already has), surely the recession risk is shrinking as unemployment reverses course.

Elsewhere, the ISM (Institute for Supply Management) Manufacturing Index remained weak, but the ISM Services Index rebounded quite nicely, from an okay 51.5 to a solid 54.9.

For investors, it is fascinating to watch how markets have moved back to the “good is good” mode of thinking, now that inflation fears have been significantly tamed.

Aided by central bank rate cuts – more on that next – a soft landing can definitely be achieved.

For investors, it is fascinating to watch how markets have moved back to the “good is good” mode of thinking, now that inflation fears have been significantly tamed. This comes after a period in which strong economic data was cause for concern given the possibility of it further inflaming inflation.

Internationally – with the exception of Germany, which has struggled recently – the economic consensus is indeed that the risk of recession is now significantly lower for developed nations than for the bulk of the past two years (see next chart).

Probability of a recession is now relatively low outside of Germany

As of 10/14/2024. Median probability of recession based on latest forecasts submitted to surveys conducted by Bloomberg. Sources: Bloomberg, RBC GAM

Smaller Federal Reserve rate cuts

Central banks are now firmly in rate-cutting mode (see next chart). The Fed was the last of the major players to join the party on September 18, with a big 50bps cut.

Central banks are pivoting to rate cuts

As of 10/10/2024. Based on policy rates for 30 countries. Sources: Haver Analytics, RBC GAM

But we recently expressed concern that markets had gotten a little ahead of themselves with the amount of rate cutting that was being priced into future decision dates, with further 50 basis-point rate cuts far from certain for the U.S.

The market has since come around to our way of thinking, thanks to several developments.

The aforementioned U.S. payrolls then arrived in fighting form, alongside other evidence of economic health.

U.S. Consumer Price Index (CPI) subsequently came in a hair hotter than expected, with core inflation rising by 0.3% month-over-month (see next chart). Even with headline CPI year-over-year (YoY) down and shelter inflation finally decelerating, the release served as a reminder that elevated inflation has not yet been completely snuffed out.

U.S. inflation surprises a touch

As of September 2024. Shaded area represents recession. Sources: U.S. Bureau of Labor Statistics (BLS), Macrobond, RBC GAM

The Fed Minutes further revealed that while the substantial majority of the September 18 meeting participants favoured the 50bps rate cut that was delivered, some (beyond the lone official dissenter) preferred 25bps, and some of those who favoured 50bps would have been happy enough to go with 25bps instead. This is not the stuff of a central bank panicked that it is behind the curve.

Yields have indeed increased since then, and rate-cut pricing has become somewhat less extreme. The market now prices in a 3.5% U.S. policy rate by next July, a significant step back from the 2.9% priced just a few weeks ago. This is gratifying, though leaves us without a juicy off-consensus view: we concur with the new consensus that a 25bps rate cut is more likely in November than a 50bps move (see next chart), and also look for a further 25bps rate cut at the final meeting of 2024.

Federal Reserve rate cut expectations for November have been scaled back

As of 10/14/2024. Sources: Bloomberg, RBC GAM

Trump likelihood mounts

After Democratic Party nominee Kamala Harris had built a small but tidy lead through September, the past few weeks have revealed a significant reversal. Harris now slightly trails Trump according to the PredictIt betting market, and indeed quite a range of betting markets (see next chart).

The presidential race is in a dead heat

As of 10/15/2024. Based on prediction markets data and RBC GAM calculations. Sources: PredictIt, Macrobond, RBC GAM

What explains the recent Harris slippage? Arguably two things.:

1. She performed poorly in some recent interviews, in particular failing to articulate how she is different from the unpopular President Biden.

2. The two recent hurricanes in the U.S. southeast may be hurting her chances. The White House response has been criticized, and the key swing states of Georgia and North Carolina were struck and so are now in a discontented state of mind going into the election. Conversely, one might note that the most affected areas tilt Republican and turnout could be incrementally lower as people prioritize putting their lives back in order over voting.

As we’ve said from the beginning, it remains a close race and the outcome will probably be determined by mere tens of thousands of votes in a small handful of states. This is not the sort of scenario that lends itself to confident proclamations in advance of the outcome.

An additional source of election uncertainty comes from the Middle East, where the risk of a further escalation in the conflict there might underline the lack of White House influence over the parties in conflict, and where any U.S. action (or inaction) might raise the ire of various electoral blocs.

We already discussed at some length the economic implications of the two candidates’ platforms in the prior MacroMemo. Our thinking has not changed significantly since then, though we have since put together a handy graphic to summarize the main drivers and outcomes (see next table).

Overall, neither candidate is expected to deliver large amounts of fiscal stimulus. Trump is perhaps more likely to provide a modicum of an economic boost in the short run, but he is then more likely to induce a small economic drag over the medium run. Inflation would probably be incrementally higher under Trump, with the stock market favouring Trump and the bond market favouring Harris.

Comparing the Trump and Harris election platforms

Estimated impacts as at 10/04/2024. Sources: RBC GAM

At least as important (economically) as who wins is whether Congress aligns in a sweep behind the winner. At present this looks unlikely, hence the fairly pedestrian economic implications discussed above. But if a sweep does occur – and these occur with a surprising frequency in presidential elections – that would open the door for more money to go gushing out into the economy, regardless of which party manages the feat.

China stimulus

Valid concerns remain about the Chinese economy. The demographic profile, friction with the U.S., housing market woes, and favoritism for the state over the private sector are all genuinely worrying. Also note:

• Money supply growth has recently slumped (see next chart) and inflation is nearly non-existent.

• Home prices are falling, property investment is down, imports are flat and retail sales are rising by a mere 2% per year.

• Consumer confidence remains quite low (see subsequent chart).

• There are reports on the ground of more than a million Chinese restaurants having closed over the first half of 2024, which is nearly as many as the entire prior year.

China’s money supply growth has dropped notably

As of September 2024. Sources: Macrobond, RBC GAM

Chinese consumer sentiment remains anemic since Shanghai lockdown

As of August 2024. Sources: China National Bureau Statistics, Macrobond, RBC GAM

All is clearly not perfectly well in China. But equally, we think the degree of concern may be overblown.

In response to speculation that China’s economy might be in outright decline if the “true” economic numbers were revealed, our alternative Chinese GDP indicators continue to insist that the economy is likely still growing at approximately the official rate (see next chart). Chinese official GDP continues to track nearly 5% growth for 2024.

Alternative indicators confirm Chinese GDP

Li Keqiang Index as of July 2024, GDP as of Q2 2024, China Cyclical Activity Tracker (CCAT) as of Q2 2024. Economic Activity Index (July 2024) constructed using 8 indicators as proxies for economic activities. Sources: Clark, Pinkovskiy and Sala-i-Martin, “Is Chinese growth overstated?” Federal Reserve Bank of New York, Liberty Street Economics, 2017; Federal Reserve Bank of San Francisco; Haver Analytics; Macrobond; RBC GAM

While housing and retail are weak, traditional sources of Chinese strength such as exports and industrial production remain strong (see next chart). There is also some tentative evidence that Chinese property transactions are starting to revive.

Monthly economic indicators for China

As of August 2024. Average of 2019 levels indexed to 100. Sources: Haver Analytics, RBC GAM

The other key support for China is that the country’s policymakers are again beginning to take action. In late September, they announced a number of major new initiatives:

• A 50bps cut to the Required Reserve Ratio, with expectations for another move by year-end.

• A range of cuts to related interest rates, including a 50bps reduction in mortgage rates.

• A reduction in the minimum downpayment on second properties from 25% to 15%.

• Additional support for local governments to purchase unsold but completed properties clogging up the housing market.

• A total of 800 billion renminbi in liquidity support spread across two programs to support stock market purchases by major Chinese financial institutions and companies.

The Chinese stock market soared in response to the liquidity support and remains materially higher than before, even though it has since given up some of the initial gains (see next chart). Global commodity prices have also risen somewhat on the view that Chinese demand could increase (see subsequent chart).

Chinese stock markets soared on stimulus announcements

As of 10/14/24. Sources: Shanghai Stock Exchange, Shenzhen Stock Exchange, Macrobond, RBC GAM

Commodity prices have climbed recently

As of 10/10/2024. Shaded area represents U.S. recession. Sources: S&P Global, Macrobond, RBC GAM

Recent reports also indicate Chinese policymakers have further plans. A particular focus will apparently be to help beleaguered local governments with their large, creaking debt loads. This will also help the many banks that have lent to these local governments. China may direct as much as 6 trillion renminbi in federal borrowing capacity for this purpose.

There are also reports that policymakers may be planning measures to support demand via the Chinese consumer. This is a long-awaited development, though one that will have to be implemented carefully given the proclivity for Chinese households to save rather than spend their money.

Expectations need to be managed carefully given that the Chinese economy is unlikely to ever return to its prior glory days of 6+% growth. To the contrary, we think a gradual deceleration toward 3—4% annual growth is the most likely scenario. But this is still enough to keep China as a global power, and to allow it to continue advancing down the same road that Japan and South Korea blazed toward developed-world status.

Oil price risk

The price of West Texas oil has increased materially over the past month, from as little as $66 to as much as $77 more recently (see next chart). This movement has largely been due to escalating Middle East tensions.

Crude oil prices rise on escalating tensions in the Middle East

As of 10/11/2024. Sources: Macrobond, RBC GAM

Even with this increase, we would acknowledge that the risk to oil prices extends more to the upside than to the downside.

Sure, concerns about global growth – and, more acutely, Chinese growth – have validity, but the global economy is more likely to manage a soft landing than not, and we believe concerns about the Chinese economy are at least slightly exaggerated.

Oil prices are still no higher than a moderate level despite the likelihood of a further intensification of the conflict in the Middle East. A reasonable approximation of a normal oil price is between $70 and $90 per barrel, and prices are still in the bottom half of this range. And there are of course scenarios in which the price of oil ventures somewhat above normal for a period of time, in the event of a sufficiently large supply shock.

In short, the price of oil is more likely to be somewhat higher than lower in both the short term and the long term.

We would further venture to guess that the price of oil is more likely to gradually rise than fall over the long run. This is in part simply to keep pace with inflation, and in part because any structural peak and subsequent decline in oil demand around the turn of the decade may be more than matched by a structural peak and subsequent decline in oil supply.

In short, the price of oil is more likely to be somewhat higher than lower in both the short term and the long term.

However, we push back against the idea that there is a strong likelihood of oil prices exploding higher due to conflict in the Middle East, and particularly against the idea that oil prices could then be enduringly stuck at an extreme price.

To be sure, there is a chance that Iranian oil extraction, refinement or shipping facilities are targeted, raising the price of oil. But a lot of this is already priced into oil, and Iran is not the oil producer that it once was, now generating just 3% of global output.

By comparison, OPEC (Organization of Petroleum Exporting Countries) is sitting on spare capacity equal to nearly 5% of global output, so it is capable of filling an Iranian-sized hole over time.

The bottom line is that oil prices are more likely to rise than fall, but we push back against the idea that prices will explode enduringly higher, even in the face of genuine geopolitical risk.

Russian energy production was shunned by western buyers after the onset of the war in Ukraine in February 2022, but Russia continues to produce and sell a huge amount of energy. As western buyers stepped back, other countries keen for a discount (or crowded out of their usual supplier by pivoting western nations) stepped up their Russian purchases. India and China have figured particularly centrally. Thus, while the price of oil initially rose, it then reversed course. Should Iran find itself further constrained in its ability to sell its oil to conventional buyers, do not underestimate its ability to follow in Russia’s footsteps.

The U.S. shale oil sector remains a key swing producer, capable of ramping up and down production in relatively short order should the price signal become sufficiently compelling. This helps to reduce the duration of global oil shocks, meaning that any spike in oil prices would probably last a shorter period of time.

It seems clear that the major players don’t particularly want higher oil prices. Consumers certainly do not. The White House doesn’t. Normally, one might argue that oil producers would, but OPEC (and by extension, Iran) should fear high oil prices because they allow the U.S. to continue to gobble up market share. They should also recognize that another bout of ultra-high oil prices would spur many car-buying households to make the leap to electric vehicles and other energy-efficient technologies, permanently reducing the demand for oil in the future.

The bottom line is that oil prices are more likely to rise than fall, but we push back against the idea that prices will explode enduringly higher, even in the face of genuine geopolitical risk.

Canadian economic update

In this section we discuss Canada’s latest job numbers (good), the Business Outlook Survey (soft but slightly improved), the country’s latest CPI report (cool), and preview the upcoming Bank of Canada decision.

Canadian job numbers

As in the U.S., Canada’s job numbers managed to soundly trounce expectations, with the 46,700 new jobs created in September easily beating the 27,000-job consensus. The rate of hiring has picked up nicely over the past few months. Recall that jobs were actually shed for two consecutive months over the summer (see next chart).

Canadian hiring back in positive territory

As of September 2024. Sources: Statistics Canada, Haver Analytics, Macrobond, RBC GAM

The hiring was private-sector oriented (+61,000), which is a good signal for the health of the economy. The unemployment rate also fell, from 6.6% to 6.5%, which was quite a relief given the prior rapid upward trend (recall Canada’s unemployment rate was as low as 4.8% in late 2022).

In fairness, while the job numbers were net positive, there were a few patches of softness. The lower unemployment rate was primarily the result of a declining labour force participation rate. Canada’s population is rising so fast that 50,000 new jobs in a month is barely keeping pace. Similarly, aggregate hours worked fell by 0.4% in September, arguing that Canadian businesses weren’t actually using more labour input despite a larger roster of workers.

For Bank of Canada watchers, it was also notable that hourly wage growth decelerated from +5.0% YoY to +4.6% YoY, finally breaking free of the 5% orbit they had been stuck in. We recently wrote about the fact that other Canadian wage metrics already show softer wage growth in Canada.

Business Outlook Survey

Canada’s latest quarterly Business Outlook Survey showed continued subdued demand, but with a distinct upward tilt in economic activity and a downward tilt in inflation pressures. Both are welcome.

On the activity side, as seen in the aggregate Business Outlook Survey Indicator, anticipated sales growth over the next 12 months and the “indicators of future sales” metric all staged slight increases (see next two charts). Perhaps broader economic activity will pick up slightly, even if hiring and investment plans remained unchanged.

Canadian Business Outlook Survey Indicator has become less negative

As of Q3 2024. Sources: Bank of Canada Business Outlook Survey, Macrobond, RBC GAM

Canadian businesses expect sales growth to improve

As of Q3 2024. Percentage of firms expecting sales growth to increase minus percentage of firms expecting less growth over the next 12 months. Sources: Bank of Canada Business Outlook Survey, Macrobond, RBC GAM

On the price side, inflation pressures appear to be continuing to decline. Company inflation expectations continue to fall across all time horizons (see next chart). The fraction of businesses expecting inflation above 3% over the next two years has fallen from 41% to just 15% over the past quarter alone.

Canadian inflation expectations continued to fall

Business Leaders’ Pulse (BLP) results as of September 2024; Business Outlook Survey (BOS) as of Q3 2024. Sources: Bank of Canada, RBC GAM

The accompanying Canadian Survey of Consumer Expectations confirms that household inflation expectations also continue to fall (see next chart). The survey also depicts improved consumer attitudes about financial stress. The fraction believing their financial situation is deteriorating or will deteriorate, perceiving that access to credit is becoming or will become harder, the probability of losing a job, and the probability of missing a debt payment have all declined nicely over the past quarter.

This is a hugely important insight at a confusing moment when the country’s policy rate is falling at the same time that people are rolling into higher mortgage rates.

Canadian consumer inflation expectations have been declining

As of Q3 2024. Sources: Canadian Survey of Consumer Expectations, Bank of Canada, Macrobond, RBC GAM

Canadian September CPI

Canada’s September CPI print was soft (see next chart). This was consistent with the views expressed in the Business Outlook survey that inflation pressures are abating.

Canadian headline CPI and core CPI

As of September 2024. Sources: Statistics Canada, Macrobond, RBC GAM

The annual headline number descended from an already tame +2.0% YoY to just +1.6% YoY. This was a below-consensus and below-target outcome. Prices actually fell for a second-straight month (by 0.4% in September, after a 0.2% decline in August), though on a seasonally adjusted basis they were flat. The main deflationary driver was lower gasoline prices.

Another key improvement was the cost of rent, which slowed from +8.9% YoY to +8.2% YoY. Shelter costs have been the last major source of inflationary pressures in Canada, and we have been predicting a deceleration in rent.

Canada has quite a range of competing core inflation metrics:

• Median CPI was unchanged and on target at +2.3% YoY.

• CPI-trim was unchanged at +2.4% YoY (though below the consensus forecast).

• CPI excluding food and energy rang in at an identical +2.4% YoY.

All of this is to say that inflation in Canada has declined and is now in a tolerable range. The headline print flatters the overall situation, but we still believe there is room for further decline given the presence of economic slack and falling inflation expectations.

Bank of Canada preview

Where does this leave the Bank of Canada? Still in a position to cut rates, but in a position of slightly less urgency than a month ago, in our view.

The need for a sequence of large near-term rate cuts has diminished with a better job number, fewer concerns about household finances, an incrementally improved business outlook and higher oil prices since the last CPI print (the last of these with relevance to both inflation and the country’s oil sector).

To be sure, rate cuts of some description still make sense given the trio of an unemployment rate above its natural rate, broadly cooperating inflation and restrictive interest rates.

On the net, we still think a 50-basis-point rate cut on October 23 is the most likely outcome, especially given the precedent set by the U.S. and given that markets already embrace a 50-basis-point move. But this is less certain than before, with a 25-basis-point move also possible. We then assume that the Bank of Canada reverts to 25 basis point cuts in December, though there will be plenty of additional data to parse before a final judgement is necessary for that meeting.

-With contributions from Vivien Lee and Aaron Ma