The economic data see-saw

U.S. employment

Financial markets have lately been choppy, with a significant recent retreat by equities in response to a range of developments. These included disappointment over chip-maker NVIDIA’s (still excellent) financial projections and the latest U.S. payrolls report, which undershot expectations.

Let the record show that the creation of 142,000 U.S. jobs in August can hardly be described as disastrous. We had gone into the announcement with the view that a print below 100,000 would probably ramp up recession concerns, a number above 200,000 would handily allay them, and a number between 100,000 and 200,000 would leave ambiguity.

So, ambiguity it is. The hard-landers can still claim this report is the latest stepping stone toward a recession. On the other hand, the-soft landers (ourselves tentatively among them) can say this is merely a part of the necessary settling process as excess pressure within the economy is bled off.

For context, recall that in the 2010s the general thinking had been that a “normal” month of job creation might well be no more than 100,000 or 125,000 new jobs per month, which this report handily clears.

But the report ultimately lands on the “slightly disappointing” side of the scale for a number of reasons.

1. The jobs number undershot the consensus expectation by a modest 23,000 positions. Incidentally, other employment estimates land in approximately the same range as the 142,000 payrolls figure: the household survey says 168,000 new jobs were created in August, while the ADP survey figures it was just 99,000.

2.  Critically, revisions revealed the creation of 86,000 fewer jobs than previously imagined over the prior two months. This has been a familiar refrain: the past five releases have all revised the prior two months lower. It is thus tempting to argue that while 142,000 new jobs were officially formed in August, this might eventually be whittled down to something closer to 100,000 by the time the dust settles (and this is before the benchmark revisions happen, which pared last year’s presumed job creation significantly).

One way or another, the rate of job creation has definitely been decelerating, albeit from an extremely high and unsustainable starting point (see next chart).

U.S. job growth has slowed significantly

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

While the net conclusion for the payrolls report must therefore be at least slightly negative, we can also highlight some good things. Aggregate hours worked across the economy rose. That might seem obvious since there were more workers than the prior month, but it doesn’t always work that way. We’ll take it.

The unemployment rate also fell, from 4.3% to 4.2%. That’s nice, since the unemployment rate had been gliding relentlessly higher prior to this. But it isn’t entirely genuine, as we suspect Hurricane Beryl-related distortions in July were unwound in August, resulting in fewer people temporarily unable to work due to weather (this fell by 412,000 people in July to just 24,000 in August). In other words, unemployment in July was unnaturally high, and then that distortion went away in August.

What appears to be genuine is the recent slight downward trend in the weekly jobless claims report. This had trended ominously higher earlier in the summer but is now reversing (see next chart). It is hard to fathom anything too sinister is happening in the labour market when the number of people qualifying for unemployment insurance is not just low but actively falling.

U.S. jobless claims stabilizing

As of the week ending 08/24/2024. Sources: U.S. Department of Labor, Macrobond, RBC GAM

What about the Sahm Rule that triggered last month when the trend unemployment rate had risen by half a percentage point from its low? It still predicts recession (see next chart). But it is important to keep in mind two things.

1. Even Claudia Sahm, who popularized the rule, has misgivings about what it is presently saying given that a disproportionate part of the increase in the unemployment rate is due to the benign force of a greater number of job seekers, rather than the malignant force of fewer jobs. The gold line in the next chart shows the inverted employment-to-population ratio, which arguably does a better job of focusing on whether jobs are actually disappearing. While the ratio has deteriorated slightly, it has not reached its own recession threshold.

U.S. employment-to-population ratio is not yet signaling a recession

As of August 2024. 3-month moving average of unemployment rate and employment-to-population ratio. Sources: U.S. Bureau of Labor Statistics (BLS), UBS, Macrobond, RBC GAM

1. No one recession signal is perfect. Some may not have been wrong yet, but none are truly perfect. We prefer to examine a basket of recession signals. Within this, the traditional Sahm Rule has indeed now been triggered (if with an asterisk), but quite a number of other recession signals have not. Even more importantly some were previously predicting a recession and have since abandoned that claim. There is still a recession risk and the U.S. labour market merits particular attention, but it is far from a recession certainty.

Another source of tentative U.S. economic weakness was the latest Beige Book report, which deteriorated for a second straight iteration and is outright weak (see next chart). Fortunately, the absolute level is still no worse than it was earlier in the year.

Beige Book Sentiment Indicator weakens

As of September 2024. The indicator quantifies the sentiment of local contacts by assigning different weights to a spectrum of positive and negative words used to describe overall economic conditions in the Fed Beige Book. Sources: U.S. Federal Reserve, RBC GAM

Elsewhere not so bad

That’s the bad economic news. There is arguably at least as much “ok” economic news. First, after a long period in which both U.S. and global economic surprises were not just negative but deteriorating, it appears that the measures are starting to stabilize (see next chart). This is a long way from reliably positive surprises, but it is notable.

Economic surprises are negative

As of 09/06/2024. Sources: Citigroup, Bloomberg, RBC GAM

U.S. small businesses, who have long been extremely pessimistic, managed a significant leap in their optimism recently (see next chart). This actually makes sense. They are highly interest-rate sensitive, and so their confidence plummeted when interest rates started to rise, and it is now beginning to recover as those same interest rates start to fall.

Small businesses have been feeling more optimistic

As of July 2024. Shaded area represents recession. Sources: National Federation of Independent Business, Macrobond, RBC GAM

The twin U.S. ISM (Institute for Supply Management) indices, which reflect sentiment in the manufacturing and service industries, both managed a slight increase in their August data (see next chart). To be sure, manufacturers are still reporting adverse conditions, but they have been consistent in this stance since late 2022 without a recession resulting. The new orders sub-component did fall notably, but it was weaker than this just over a year ago, and the employment component managed to rise. The service sector, meanwhile, is cautious but ultimately in line with modest growth.

Both U.S. purchasing managers’ indices (PMIs) rose slightly in the latest month

Manufacturing PMI as of August 2024. Services PMI as of August 2024. Shaded area represents recession. Sources: Institute for Supply Management (ISM), Macrobond, RBC GAM

To be filed in the “is this actually anything?” department alongside the previously referenced stabilization in economic surprise indices, there is the slightest of hints that U.S. household credit delinquencies are either stabilizing or deteriorating less quickly (see next chart). Auto loan delinquencies appear to have tentatively flattened out, while the rate of increase for credit card and mortgage delinquencies appears to be slowing. It would be nice if falling interest rates are already starting to help.

U.S. consumer loan delinquency is now rising

As of Q2 2024. Shaded area represents recession. Sources: Federal Reserve Bank of New York, Macrobond, RBC GAM

The bottom line is that the economic deceleration is a) pretty mild where it is occurring, and b) not universal. The hard landing risk is still real, but a soft landing remains somewhat more likely in our view.

Central bank actions

The era of rate cuts continues. Since our last #MacroMemo, the Bank of Canada cut its policy rate for a third consecutive time, with several more seemingly on offer given the Bank’s statement that it is “reasonable to expect further cuts.” Indeed, not only has inflation continued to fall in Canada but the economy is definitely suffering.

Despite the addition of 22,100 new jobs after two months of outright declines (see next chart), the unemployment rate continues to rise with a worrying haste (see subsequent chart). While we formally look for further 25 basis point rate cuts, the Bank of Canada is in a better position than most to at least contemplate a larger move. Indeed, one got the impression that the Bank of Canada may have debated precisely that based on how Governor Macklem equivocated when asked the question point blank by a journalist.

Canadian job market has weakened

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

Canadian unemployment rate has been rising

As of August 2024. Shaded area represents recession. Sources: Statistics Canada, Haver Analytics, Macrobond, RBC GAM

As this #MacroMemo goes to print, the European Central Bank is on the cusp of its own second rate cut, with expectations for a third by year-end.

That leaves the U.S., which is scheduled to deliver its first rate cut of the cycle on September 18. Fed speakers have reasonably clearly endorsed this as the starting point.

The market continues to flirt with the notion that it could even be a 50-basis-point rate cut – going so far as to price in a nearly 50-50 shot right after the weak payrolls report – but this expectation has since receded to just a 30% chance and we believe the true odds are even lower than that. A 25-basis-point move is more likely unless there is some sudden economic deterioration between now and then.

After that, the market prices in rate cuts at every meeting through the middle of 2025. This could very well happen, though we again flag the chance that it all proceeds a bit less quickly than that. Accordingly, bond yields may have already fallen as far as they need to.

Monetary policy asymmetry

Herein we posit that a fixed quantity of monetary restraint is more powerful than an equivalent quantity of monetary stimulus, and furthermore that rate cuts may be felt more quickly than rate hikes. Both notions are not just interesting to contemplate but have relevance to the current situation: the first idea argues that the rate cuts now underway “count for more” since they are removing monetary restraint; the second idea argues that the benefit of the rate cuts may be felt a bit more quickly.

Restrictive versus easy monetary policy

Let us start with the idea that restrictive monetary policy is more powerful than easy monetary policy. Calculations from the Richmond Fed argue that a percentage point of monetary tightness is around three times more powerful than a percentage point of monetary stimulus. Are we saying that a central bank has to cut by three percentage points just to unwind one percentage of rate hikes? No – that would be madness in that the neutral policy rate would have to be in perpetual descent from one cycle to the next. 

The idea is instead that setting restrictive monetary policy that is one percentage point higher than the neutral rate should elicit an economic drag that is about three times larger than the stimulus generated by setting the policy rate one percentage point below neutral.

Conveniently, this may help to explain why central banks have tended to deviate significantly below their neutral rate when times are bad but have ventured less far above neutral when the going is good (or, as in the recent episode, when inflation was much too high). The current U.S. federal funds rate is just 2.5 percentage points above neutral (estimated at around 3.0%) despite the threat of inflation that overshot target by more than 7 percentage points. In contrast, central banks haven’t given a second thought about cutting rates to 2.5 percentage points below neutral during a recession when the inflation miss to the downside was considerably smaller than this.

Why might restrictive monetary policy bite disproportionately? The banking sector often behaves differently when rates become high, disproportionately restricting access to credit due to concerns that borrowers are more likely to default. Companies, conversely, tend to cut their output rather than lower prices and wages when conditions are bad, requiring more rate cutting to restore economic health. Consumers also appear to be come disproportionately pessimistic during bouts of economic weakness than they are optimistic during periods of strength, requiring more rate cutting to offset the former situation.

In the present context, as monetary policy becomes less restrictive, each rate cut is arguably worth somewhat more than normal as that restraint is removed.

Rate cuts hit faster than rate hikes?

Monetary policy always has a lagged impact, whether loosening or tightening. In particular, it takes time for fixed-rate loans in the economy to reset. But we posit that the rate of monetary transmission could come a bit faster as rates are falling than as they are rising, at least in the U.S.

This notion is entirely due to their optionality embedded in the U.S. mortgage market. American households with mortgages have the option of resetting their mortgage rate at any time, for a fee. With a 30-year mortgage that has now fallen from above 8% to below 7%, this is already becoming feasible for people who took out a mortgage near the interest rate peak.

The main point is that rate cuts from a high starting point can conceivably help to stabilize the economy slightly faster than conventional models might expect.

The reverse situation does not exist: when interest rates were rising, lenders did not have the ability to reset their fixed mortgage loans into higher rates. Thus, American households are hit by higher interest rates more slowly than they are helped by lower rates.

To the extent that rates are still fairly high and a large fraction of Americans with mortgages managed to lock in their rates at extremely low levels that won’t be seen again for years, if ever, it is arguably a smaller-than-usual cohort of Americans who stand to benefit. In turn, the accelerated effect of falling rates is probably smaller than usual. But it still exists.

None of this is earth shattering stuff. But the main point is that rate cuts from a high starting point can conceivably help to stabilize the economy slightly faster than conventional models might expect.

USMCA re-opens in 2026

We wrote last month about the possibility of new U.S. tariffs after the upcoming election. A further issue of Canada- (and Mexico-) specific relevance is that the USMCA free trade agreement between the U.S., Mexico and Canada will also be due for renewal during the next U.S. presidency.

Recall that the USMCA came into force, replacing NAFTA on July 1, 2020. But it is not written in indelible ink.

1. There exists – as there did previously with NAFTA – the option for any party to withdraw from it with six months’ notice at any time. But it is unlikely that any party would trigger this. Canada and Mexico appreciate the importance of a close U.S. economic connection. Republican nominee Trump has protectionist inclinations, but he negotiated the USMCA and so is unlikely to destroy it. For their part, the Democrats have shown no inclination to kill the USMCA.

2. The USMCA automatically expires after 16 years (on June 30, 2036) unless all three parties confirm they wish for it to continue. While an opt-in is considerably trickier than an opt-out given the need for support from sometimes fickle legislative bodies, it is at least far in the future.

3. Of relevance to the upcoming presidential term, there will be a “joint review” by all parties of the USMCA on July 1, 2026. This is an opportunity for countries to raise issues with the USMCA and potentially renegotiate aspects of it. This is the first major trade agreement to have such a mechanism.

Issues will have to be raised with the review body by June 1, 2026, and the U.S is further obliged to report to Congress on its plans 180 days before the joint review, meaning that potential changes from the U.S. will come into focus by late 2025.

Regularly modernizing the trade deal has some advantage given the shifting trade landscape over time. But there is also a major cost. The uncertainty associated with the review mechanism discourages investors and businesses from making major long-term investments across borders.

Incidentally, the joint review presents the option of locking into another 16 years of stability, rather than waiting until 2036 for this long-term renewal. But if the participants opt not to pursue this option, further joint reviews will then happen annually, resulting in yearly jolts of uncertainty around the rules governing North American trade.

Realistically, the U.S. and its gargantuan economy is in the driver’s seat for this review. It is expected to target Mexico on matters of agriculture, energy and labour. It will likely also target how Chinese companies are using Mexico as a backdoor into the U.S. market, evading Chinese tariffs. The U.S. might again target Canada’s forestry sector and supply managed industries, as well as the recently introduced Digital Services Tax.

Regularly modernizing the trade deal has some advantage given the shifting trade landscape over time. But there is also a major cost. The uncertainty associated with the review mechanism discourages investors and businesses from making major long-term investments across borders, as there is the possibility that a sector might later be impeded.

Elsewhere in the realm of North American tariffs, Canada’s decision to follow the U.S. lead and apply large tariffs against Chinese-made vehicles has resulted in China commencing a probe into Canadian canola exports that threatens to culminate in a tariff.

Drilling into Canadian housing

Canadian home prices remain soft, continuing to move roughly sideways as they shift across the seasons (see next chart).

Canadian home prices by market

As of July 2024. Sources: Canadian Real Estate Association, Macrobond, RBC GAM

We continue to budget for a few more years of home price weakness. This is in part informed by the historical pattern from Canada’s last major housing bust in the early 1990s, and in part because affordability is still quite poor and has only barely begun to improve (see next chart).

Canadian housing affordability remains very poor

As of Q2 2024. Current carrying cost of a home versus the historical norm. Sources: Canadian Real Estate Association, Statistics Canada, Haver Analytics, RBC GAM

The number of existing home transactions per capita has declined greatly since the pandemic peak and is also now low by the standard of the prior two decades (see next chart). But activity appears to have stabilized and is no worse than during the last housing bust in the 1990s.

Canada existing home sales per capita has stabilized

As of July 2024. Sources: Canadian Real Estate Association, Statistics Canada, Macrobond, RBC GAM

While the number of homes for sale has increased quite a lot relative to pandemic lows, this is really just a reversion back to the pre-pandemic norm (see next chart).

Housing inventory in Canada has increased

As of July 2024. Shaded area represents recession. Sources: Canadian Real Estate Association, Macrobond, RBC GAM

A classic measure of the real estate market is the home sales-to-new listings ratio. This shows that while it is clearly no longer a seller’s market, it hasn’t actually become an outright buyer’s market (see next chart).

Canadian home sales-to-new-listings ratio point to a balanced market

As of July 2024. Sources: Canadian Real Estate Association, Macrobond, RBC GAM

Declining Canadian interest rates are obviously helpful (see next chart), but the absolute level of rates is still quite high and the initial rate cuts have not unleashed a wave of new buying. This suggests rates will have to be materially lower before a wave of new buyers will emerge.

Canadian bond yields fall as central bank cuts rates

As of 09/04/2024. Shaded area represents recession. Sources: Haver Analytics, Macrobond, RBC GAM

Overall, Canada’s housing market is certainly weak, but not especially unbalanced.

The picture becomes somewhat less friendly when you dig into some of Canada’s larger markets, like Toronto and Vancouver. We focus on Toronto here. The city’s home sales-to-new listings ratio has already fallen into buyer’s market territory, meaning that the number of new listings is running ahead of sales to an unusual degree (see next chart).

Toronto home sales-to-new listings ratio points to a buyer’s market

As of July 2024. Sources: Canadian Real Estate Association, Macrobond, RBC GAM

Like Russian nesting dolls, we can dig down one further level, identifying an even more acute source of weakness: Toronto’s multi-unit market. The city’s condo sales-to-new listings ratio has fallen even more sharply and to an even lower ratio (see next chart).

Toronto condo sales-to-new listings have dropped markedly

As of Q2 2024. Sources: Toronto Real Estate Board, Macrobond, RBC GAM

New listings of Toronto condos for sale and for rent have both risen quite a lot and continue to skyrocket (see next chart). This is an unbalanced market, and one that is showing some distress, presumably for a mix of reasons:

• Some owners cannot afford their mortgage in this higher rate environment.

• Some cannot make money off of their condo now that rents trail the cost of maintaining an equivalent mortgage (see subsequent chart).

• Some have given up on making money on their condo as a speculative investment now that condo prices are falling.

Toronto multi-unit listings have risen

As of Q2 2024. Sources: Toronto Real Estate Board, Macrobond, RBC GAM

Renting is now more affordable than buying a condo in Toronto

As of Q2 2024. Average rents of apartments of all bedroom types. Mortgage payments are estimated using MLS HPI Benchmark Prices for apartments and fixed mortgage rates for 5 years and over from Bank of Canada, assuming 20% down payment and 25-yer amortization. Sources: Canadian Real Estate Association, Bank of Canada, Toronto Real Estate Board, Macrobond, RBC GAM

On the condo construction side, new projects are stalling out. This is in part due to the surge of existing units now on the market, in part because the cost of financing for builders is challenging and skilled construction labour remains in short supply, and in part because – despite massive population growth – the buyers simply aren’t there. New construction projects in Toronto normally presell about 70% of their units, which serves as both a funding tool and also confirmation of the viability of a project. That presell share has now fallen below 50% and is continuing to plummet, rendering many projects unviable.

While the numbers vary depending on the market, the Globe & Mail reports that, across Canada, the country is on track to hit approximately 240 real estate insolvencies this year. That’s 57% higher than in 2023. And that excludes the developers and projects that have instead gone into receivership. The condo market appears set to remain especially soft in Canada.

Quick hits

Canadian politics

The NDP withdrew their support from Canada’s governing Liberal Party, raising the theoretical risk of a snap election. The government is already unusually old by the standard of prior minority governments.

But we judge an imminent election to be unlikely. It is not just the Liberals but also the NDP that are down in the polls relative to the last election, and so this is potentially an effort by the NDP to distance themselves from their long-time Liberal partners before an election next year.

Both parties will presumably find a way to fend an election off until next year. However, the scope for major policy achievements over that year will now presumably be somewhat diminished.

The next Canadian election has to be held by October 2025. It will presumably occur fairly close to that date given the high likelihood of a new government. Polls presently show the opposition Conservative Party to be approximately 17 percentage points ahead and on track to win a large majority with 212 out of 343 seats.

Of course, much could change over the coming year. But if the lead comes even close to holding, Canada would have a new government with a commanding mandate in a year’s time. On the heels of an extended period of poor Canadian productivity growth and lower confidence, there is a fighting chance that a new more rightward leaning party (albeit with populist inclinations that muddy the economic water) could help to revive these lagging forces.

Imminent hurricane disruption

Hurricane Francine is now swirling in the Caribbean, preparing to make U.S. landfall in the evening of September 11 near New Orleans. This could temporarily distort the U.S. economy in a number of ways, depending on its severity and whether large metropolitan areas are affected.

German economic weakness

The German economy has been “the sick man of Europe” for some time but is faring particularly poorly recently. Two particular headwinds are:

• soft Chinese demand for German manufactured products in the context of an underwhelming Chinese economy

• significant auto sector turmoil across Europe as Chinese carmakers flood into overseas markets, displacing European brands.

German industrial production is down 5.9% YoY and the country’s composite PMI (Purchasing Managers’ Index) is just 48.4 (sub-50 indicates decline). GDP has declined in two of the last three quarters, though the third quarter of this year is expected to manage a return to slight growth.

UK looking good

Conversely, the UK economy is suddenly looking good after a horrible 2023. Part of the rebound is no doubt due to the natural buoyancy that comes from performing especially poorly earlier. Unlike most countries, the UK manufacturing PMI is actually above 50 (52.5). The services PMI also looks pretty good compared to most countries (53.7). Hiring is rebounding and monthly GDP is again rising fairly quickly. Not all parts of the world are decelerating economically!

-With contributions from Vivien Lee and Aaron Ma