The U.S. labour market has kicked into high gear, with the unemployment rate falling to 6.0% in March and headed much lower according to a recent survey of consumer sentiment. While payrolls are still down 8.4 million since the pandemic began, we expect more than one million to be regained in April alone. Rather than weak demand, it's the supply side that appears to be holding back hiring in some industries, even for lower-skilled jobs. Many companies are having trouble calling back workers or filling new positions, citing virus fears, child-care duties, and expanded UI benefits as obstacles. The participation rate is still almost 2 ppts below pre-pandemic levels, though it should rise as more people are vaccinated, thus supporting job growth and allaying wage pressures. A rising participation rate will also slow the jobless rate's descent, though it should return to the pre-pandemic level of 3.5% by late 2022.
Inflation pressures are simmering in response to massive policy stimulus, surging money growth, booming resource prices, and supply-chain disruptions. The CRB commodity price index is at an 11-year high. Lumber prices have quadrupled in the past year, while copper is at ten-year highs, and wheat and corn prices are also on a roll, flagging higher food costs. Along with semiconductor and other parts shortages, many factories can't find skilled workers. Consequently, more companies are saying they will try to pass higher input costs onto consumers. If enough firms do so, it could sustain the looming spike in year-over-year measures of inflation stemming from low base effects, especially if workers demand higher wages as compensation. While core measures of inflation are far from boiling over, pressures are starting to stir beneath the surface, in areas such as furniture, appliances, and personal care services. Moreover, the hammered travel industry is seeing a reversal in price declines amid rising pent-up demand for flights, hotels and auto rentals. We expect CPI inflation to average 3.0% in 2022, the highest annual rate in a decade. But the risks are squarely on the high-side, especially if policymakers keep pressing on the accelerator and cause the economy's engine to overheat.
The Fed wants inflation to move moderately above the 2% target for some time to compensate for past undershooting. Only time will tell whether that's a wise strategy. It clearly raises the risk of a much larger overshoot. However, if inflation is held in check by long-run forces such as automation, globalization and an aging population, as Chair Powell suspects, then the Fed could achieve its aim of a more inclusive recovery, where even the hardest-hit workers regain employment. We expect policy rates to stay near zero until early 2023, a few months sooner than previously thought. The Fed should then raise rates gradually, assuming inflation stays contained. If not, rates will rise sooner and faster, risking an economic downturn.
While the 10-year Treasury rate has steadied in recent weeks after spiking more than 60 bps this year, we expect it to trend modestly higher to 1.75% at year-end and to 2.00% by late next year. From Powell's recent remarks, the Fed likely won't begin tapering asset purchases until much later this year, which should provide near-term support to the bond market.
After showing surprising resilience to the second wave of the virus and new restrictions in the winter, Canada's economic growth is set to stall in the second quarter in response to aggressive new constraints to arrest a third wave of cases. Thankfully, the hearty rebound at the turn of the year has taken real GDP to within 1.3% of pre-pandemic levels, with the remainder expected to be sopped up by year-end. Based on Statistics Canada's strong flash estimate for March GDP (0.9% m/m), we have upped our Q1 growth call to 6.5% annualized. That's actually a little better than the U.S. rate, despite stricter restrictions in Canada and massive stimulus payments in the U.S., a testament to the economy's ability to partly adapt to the pandemic.
The same forces pushing the U.S. economy faster—massive fiscal stimulus, pent-up demand, hefty household savings—are set to drive Canadian GDP skyward in the second half of the year. The recent federal budget announced another $101 billion of new spending over three years, half of which will hit this year, amounting to 2% of GDP. Meantime, the housing boom south of the border (despite rivaling that of the 2006 bubble) is mild compared with Canada, where benchmark home prices rocketed 20% y/y in March and many rural areas are seeing gains of over 30% (and don't even talk about cottage country). Record sales have easily soaked up record listings. How much longer the buying frenzy will (or can) last is anyone's guess. Policy proposals to date (including, a tax on vacant property held by nonresidents and a higher qualifying rate on uninsured mortgages) will have only a modest impact. Eventually, eroding affordability should start clamping down on demand. We do not expect a pullback in house prices, but this assumes the market will cool to more sustainable rates soon; otherwise a correction would be inevitable. Barring a housing downturn or more pandemic trouble, Canada's GDP is expected to grow 6.0% in 2021 and 4.5% in 2022, a healthy rebound from last year's 5.4% contraction.
A fierce rally in commodity prices is also helping the economy, likely turning the Q1 current account into surplus for the first time since 2008. While oil prices appear to have steadied near pre-virus levels and close to long-term norms in real terms, that's not the case for most of the other key resources that Canada sells abroad. The Bank of Canada's ex-energy commodity price index has shot up nearly 30% in the past six months to all-time highs. This, along with a recent hawkish turn by the central bank, has pumped the Canadian dollar to more than three-year highs above 81 cents US (below C$1.23). The loonie is the top-performing currency this year (not counting the crypto kind). Resource prices are expected to ease moderately as more supply comes online and as consumer spending is diverted toward the service sector. Still, prices should remain supportive, and with the BoC likely to raise rates before the Fed, the loonie looks to have found a higher flight path. We see it cruising to 83.3 cents at year-end and to 85.1 cents (C$1.175) by late 2022.
The Bank of Canada recently announced it would start reducing the pace of government bond purchases to $3 billion per week from $4 billion. This wasn't a surprise, but attributing the taper solely to a sharply upgraded economic outlook was (as opposed to concern that the Bank already owns more than 40% of federal supply). The Bank now believes the economy's slack could be absorbed in the second half of 2022 rather than in 2023. Accordingly, we pulled forward the timing of rate liftoff by several months to early 2023. Like the Fed, the Bank is willing to tolerate some upward drift in inflation, as its 1%-to-3% target range affords some flexibility. We see the Bank's three core measures of inflation, currently averaging a tick below 2%, trending modestly higher next year. But, as in the U.S., the risks appear to be all on the upside.