North American Outlook
October 08, 2024 | 08:21
Sticking the Landing
Economics
Economics
United StatesThe U.S. economy keeps chugging along. Real GDP growth picked up in the second quarter to 3.0% annualized, offsetting the slow start to the year. Spending by the big three engines—consumers, businesses, governments—was solid. Household purchases were supported by the positive wealth effect from rising equity and home prices and by real wage gains. The sole soft spot was construction, both residential and commercial, with the former weighed down by weak affordability and the latter held back by a struggling office market. Recent data suggest the third quarter got off to a slower start, with growth likely downshifting to 2.2%. However, consumers still have something left in the tank, likely spending at around a 3% annual rate and keeping overall growth above potential. Some further slowing is expected in the fourth quarter, with minimal impact from a recent three-day strike of dockworkers on the East and Gulf Coasts. For 2025, growth should remain healthy at 1.9%, close to potential. This assumes the status quo after the November 5 elections, with Congress staying divided and fiscal policy remaining supportive. Labour markets have loosened but remain healthy. After slowing to a monthly pace of 147,000 in the second quarter from 267,000 in the first quarter, nonfarm payroll gains picked up to 186,000 in the third quarter, somewhat better than normal. The unemployment rate retreated to 4.1% in September after rising to 4.3% in the summer. This is slightly below the Fed's estimate of the 'natural rate' of unemployment that's consistent with stable inflation. We expect the jobless rate to rise only modestly to 4.4% next year, one percentage point above the half-century low reached earlier this cycle but about one percentage point below the three-decade mean. |
A somewhat looser labour market should douse the few remaining inflation embers in the service sector. Providing an assist will be strong productivity growth, with the 2.7% y/y advance in Q2 holding unit labour costs to a minimal 0.3% rise, the least in a decade. Besides muting the inflationary impact of rising wages, sturdy productivity is padding margins, boosting before-tax corporate profits 11% y/y. With these two disinflation forces in play, inflation has resumed a downward course after a surprising upturn earlier this year. The Fed's preferred measure, the price index for personal expenditures, is up just 2.2% in the past year to August. Although the core rate is running higher, at 2.7%, it should trend downward, especially with asking rents continuing to moderate. With inflation within reach of the target, the Fed is "attentive to the risks to both sides of its dual mandate". The aim now is to prevent the jobless rate from rising further, keeping the soft landing intact. The strong September jobs report suggests policymakers will settle for a smaller 25-bp move on November 7. We continue to lean toward a series of quarter-point cuts amounting to a further 200 bps, taking the federal funds target range down to 2.75%-to-3.00% in early 2026. After plumbing a 15-month low of 3.6% in mid-September, the 10-year Treasury yield has backed up to 4.0% on stronger economic data and an upturn in oil prices arising from the growing conflict in the Middle East. However, we still expect the yield to fall toward 3.4% by late 2025, before reversing somewhat as the economy firms. Thirty-year mortgage rates have declined more than one percentage point since October 2023, but remain about two percentage points above two-decade norms. As borrowing costs fall further, green shoots should appear in depressed home sales. Much is riding on the outcome of the November elections with the race too close to call. For forecasting purposes, we assume the status quo: the Democrats retain the White House and Congress remains divided, impeding Harris' plans to raise corporate tax rates and expand the child and earned income tax credits. The virtual gridlock would leave the budget deficit little changed (though still huge at almost 7% of GDP), with modest effect on the economy. In the event of a Democrat sweep of Congress, a more expansionary fiscal policy under Harris would provide a moderate lift to growth. Alternatively, a Trump victory backed by full Republican control of Congress would usher in lower corporate taxes, lighter regulation, and an even larger budget deficit, giving the economy an extra boost. But it could also lead to higher interest rates and a possible trade war that undermines growth in the medium term. CanadaCanada's economy has underperformed its major trading partner and potential. Although growth improved slightly in the second quarter to 2.1% annualized, the yearly rate of 0.9% pales against 3% growth for the population and the U.S. economy. Business investment jumped last quarter and growth was flattered by a surge in government spending. By contrast, consumer spending came to a crawl as fixed-rate mortgage payments continued to reset higher. The housing market is also in the doldrums, as home buyers greeted the Bank of Canada’s initial rate cuts with a collective shrug. As inventory continues to rise, prices are generally flat to lower in most regions. A recovery is on the way due to lower interest rates and new mortgage rules, but it won’t be V-shaped. A flat initial estimate of August GDP suggests growth downshifted to 1.3% in the third quarter. For all of 2024, Canada's economy likely grew 1.1%, slightly less than last year's pace. However, further interest-rate relief should fan a moderate pickup to 1.8% in 2025. Despite the sour economy, employment growth remains decent at 1.6% y/y (317,000) in August, a testament to the nation's dismal productivity record. But much of the strength is in the public sector, notably health care, education and public administration, which are all sporting yearly gains of at least 5%. And, with still-strong immigration fanning the labour force, the unemployment rate has spiked 1.8 ppts in the past two years to 6.6%. A further rise to above 7% is expected by early next year, before a firmer economy and slower population growth rein it in a bit. The federal government has tabled plans to slash the number of international students and temporary foreign workers, and is even considering a reduction in permanent resident targets. Annual population growth could fall to around 1% for a couple of years, which will relieve pressure on the jobless rate but might also dampen housing market activity. The one good thing about a rising jobless rate is that CPI inflation has returned to the 2.0% target more quickly than anticipated. Accordingly, the Bank of Canada has delivered interest-rate relief while pledging even more. Following a third rate cut in three months, Governor Macklem said "with inflation getting closer to the target, we need to increasingly guard against the risk that the economy is too weak and inflation falls too much ". We expect an additional 175 bps of reductions by July 2025, bringing the policy rate to a moderately stimulative level of 2.5%. Risks lean toward an even faster pace of easing if the economy fails to pick up. The Fed's aggressive start to the easing cycle brought some relief to the beleaguered Canadian dollar, which was facing its darkest days since the 2020 shutdowns. Unfortunately, the loonie's outlook remains downbeat given persistent weak productivity and negative interest-rate spreads with the U.S. We expect the loonie to weaken modestly and test |
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