Talking Points

August 07, 2026 | 13:16

Pump & Circumstance

Economist

Douglas Porter , CFA

Chief Economist and Managing Director
Economics

Douglas Porter brings more than three decades of experience analyzing gl... (Read more)

Douglas Porter , CFA

Chief Economist and Managing Director
Economics

Douglas Porter brings more than three decades of experience analyzing gl... (Read more)

So much for the series of upcoming Fed rate hikes. The combination of last week’s wishy-washy-on-hikes press conference, a pullback in energy prices, and a surprisingly soggy July payrolls result has thrown a wet blanket on tightening prospects. After hitting multi-year—and in some cases multi-decade—highs last week, bond yields stepped back from the cliff in a bullish steepening move. Two-year Treasuries fell 8 bps to below 4.2%, as odds of a September hike fell below 50%, while 30s dropped 5 bps to 5.2%. Equities had zero issues with the soft employment result, but loved the milder rate outlook, and accordingly enjoyed the persistently robust Q2 earnings. After a mild summer stumble, the S&P 500 roared back to hit record highs Friday, bouncing almost 6% in just over a week. The TSX is also on a heater, rising 3% this week to new all-time highs and up 30% y/y.

The coast is not yet clear on the rate outlook, with the next major hurdle the crucial inflation data for July and August. Markets won’t have a long wait, as Wednesday’s U.S. July CPI is the headline event for next week. Gasoline prices will actually act as a dampener, with average pump prices managing to recede slightly in the month, even as energy prices spent most of July rising. That will help hold overall prices to a 0.2% m/m rise, keeping the yearly inflation rate steady at 3.5%. More encouraging, core CPI is also expected to rise 0.2%, which would shave the underlying inflation rate to 2.5%. While, yes, still above the 2% target, it would match a five-year low and bring us back close to pre-pandemic norms. Purists would quickly note that the Fed targets the PCE price index, as confirmed by Chair Warsh last week, and it has been running hotter at 3.3%—at least until upcoming (and mildly controversial) revisions, which are expected to clip a couple ticks from the annual rate.

Looking a bit further ahead, there were some encouraging developments for the inflation outlook this week. First, amid the see-sawing on the deal-or-no-deal with Iran, oil prices on net took a big step back, with WTI falling 8% to $78. And, arguably more importantly, product prices also finally fell more or less in sync, with wholesale gasoline prices dropping below $3/gallon. Just as everyone got reacquainted with crack spreads as they soared to a high above $70/barrel last week, product prices calmed a bit (taking the 3-2-1 spread to around $60, versus a more normal level of about $20). Second, unit labour costs rose at just a 1.3% annual rate in Q2, held back by decent productivity gains. These costs are a key driver of core inflation, and they are up just 1.4% in the past year. And, finally, the wage tally from payrolls was tame, with average hourly earnings rising 0.1% m/m, trimming the annual rise to 3.2%. In other words, wage growth is all the way back to pre-Covid norms, and is one less inflation worry for the Fed.

While the inflation side of the Fed’s dual mandate is still a matter of debate, the employment side was suddenly jolted with a very different outlook after July’s payroll release. Even beyond the surprising 23,000 drop in payrolls, the overall tone was soft. Private sector payrolls came in light at +30,000, matching the revised June gain, but barely half the already-mild trend over the prior year. Total hours worked were flat, net revisions chopped 103,000 jobs from the prior two months, factory payrolls have dipped in the past year, retail employment has barely grown, and wages rose just 0.1% in the month.

The only counterpoint for the hawks is that the jobless rate fell yet again by a tick to 4.1%, even with the weak payroll figure. A drop in the labour force explains the seeming disconnect, pulled down by both a slowdown in the underlying population, but more importantly by a sustained plunge in the participation rate. The part rate is the share of the adult population that has a job, or is looking for a job, and it has careened down to 61.4%, a full point below last year’s average. Aside from some pandemic weirdness, that is the lowest U.S. participation rate since early 1976, or more than 50 years ago. We would hasten to add that much of this deep drop is simple demographics—not to put too fine a point on it, but it’s the baby boomers retiring out of the workforce. The estimated part rate from the prime working age population (16-64) isn’t doing anything out of the ordinary (Chart 1). And July’s data thus drives home the point that the break-even rate of job growth needed to keep the unemployment rate steady really isn’t that far from zero.

Who had this on their bingo card a year ago, or even three months ago: Canadian job growth has handily topped U.S. trends over the past 12 months. The rollicking 75,100 jobs jump in July lifted Canadian employment 0.9% above year-ago levels. While far from robust, that’s certainly a sturdier pace than many would have dared to call for a year ago, as the trade tiff raged and governments across the land rolled out support measures for various hard-hit sectors. In comparison, U.S. payrolls are now up just 0.2% y/y (and 0.5% for private sector jobs), while the household survey reports a 0.6% y/y drop. (Canada’s payroll report runs nearly two months late, but as of May, it showed a 0.6% y/y rise in jobs, very close to the LFS at that time.)

Without agonizing over the details, the big picture is that the Canadian economy appears to be rebounding smartly from the pronounced lull from early 2025 to early 2026. We’ve seen that both in a three-month string of sturdy job growth but also in the broader GDP figures. As noted a week ago, the upbeat growth figures through the spring have put to rest chatter about a technical recession. But, just since then, there’s also been solid trade data for June, which showed that trade volumes added heavily to Q2 growth, and now a very strong trend in total hours worked. With the latter up 0.6% in July alone, they’re on pace to rise at nearly a 4% annualized rate in Q3. We have thus revised our call on Q2 GDP up to 3.8% (two weeks ago, it was 2.3%). While we had been quick to say that pace was not sustainable, and were looking for a cooldown in Q3 to 1.3%, the jobs data suggest that’s far too conservative.

Of course, the lingering cloud of uncertainty around the trade relationship with the U.S. looms large, and will keep us from additional forecast upgrades just yet. But the overall sense is that the economy has absorbed the trade blow, and is moving on, supported by the growing wave of investments in resources and defence industries. And Friday also brought a series of tantalizing headlines about serious negotiations to avert the August 19 U.S. tariffs. Along with the mix of solid Canada/soggy U.S. jobs data, the Canadian dollar rose to its best level in more than two months at 71.8 cents (or $1.393/US$).

For the Bank of Canada, the sudden run of upbeat domestic economic news lands just as the hiking fever in the U.S. has broken and as Canada’s core inflation trends are moving right back into line with the target. The net result is that markets have maintained a small chance of a rate hike by year-end, with short-term rates nudging slightly higher on balance for the week, even as long-term yields backed off somewhat. We continue to look for no move by the BoC this year; officially we also have no move penciled in for 2027 either, but even this (normally dovish) space would allow that the risk for next year is now higher, not lower, rates.