June 02, 2023 | 13:02
The Ceiling Can't Hold Us
We are nudging up our near-term growth estimates for North America, in a nod to a stream of better-than-expected economic indicators. As well, with the pseudo-drama of the debt ceiling now put to rest, one big overhanging risk has been brushed aside. The headline U.S. nonfarm payroll gain of 339,000 put an emphatic punctuation mark on the run of high-side surprises. While the details were much less impressive, the big picture is that the economy continues to grind forward, and the job market remains tight. It’s a similar story for Canada, where the Q1 GDP figures handily topped already-solid expectations, and early indications point to at least modest growth in Q2. In other words, the much-anticipated and long-awaited recession has been pushed further back.
The financial market response to the twin developments of a signed-sealed-delivered debt deal and a solid payroll report was muted. Bond yields somewhat surprisingly eased for the week, after a big bounce since mid-May. Stocks fared a bit better after a squishy start, with the recent tech revival fanning out to other sectors as well. Even the TSX, which struggled through a miserable May—down 5.2%, its worst showing for that particular month since 2012—ended the week on the upswing. A comeback in oil prices, from mid-week depths of around $67 to back around $72, helped the cause.
On the U.S. economic front, the mixed nature of the employment report was echoed in the bulk of releases this week. For every powerhouse result, such as a rebound in job openings to above 10 million, there was a dud, like pronounced weakness in the Chicago PMI. Even individual releases had crosscurrents: the national ISM flashed serious softness for orders, prices, and supplier deliveries, but also some strength in production, exports and employment. While the latter didn’t translate into factory payroll gains last month, most sectors were hiring. And the overall job gain was exactly in line with the 12-month average increase (also 339,000), suggesting no loss of hiring momentum. Still, the competing household survey reported a 310,000 job loss in the month, lifting the unemployment rate 3 ticks to 3.7%. Fun factoid: the U.S. jobless rate is now above year-ago levels (albeit by just a tick), which is the first time that has happened in any month since 2010, aside from the first year of the pandemic.
In addition to the back-up in the jobless rate, total hours worked dipped 0.1% in May, and are down so far in Q2 versus the prior quarter. Meantime, auto sales are headed for their best quarter in two years even with a retreat from solid April levels last month. Finally, the housing market continues to show a pulse, with home prices edging up recently. After falling steadily through the second half of 2022, Case-Shiller prices are now up two months in a row, and are still clinging to small year-on-year gains. Combining these many strands together, we now expect the U.S. economy to grind out a moderate 1.0% GDP gain in Q2, akin to the 1.3% Q1 outcome, and a notable upgrade from our prior view of a small dip. We look for output to slip in each of the next two quarters, but have revised up our full-year call on growth to 1.3% (from 1.0%).
For Canada, the 3.1% rise in Q1 GDP had solid details, including a 5.5% advance in final sales, and a surprise +0.2% estimate for April puts the economy on course for at least modest growth in Q2. That’s arguably even more surprising than in the U.S., given the economy was dealing with the public sector strike and the hit to oil output from wildfires. Like the U.S., we have pushed out the modest GDP decline into the second half of the year, and also upgraded the full-year call 3 ticks to 1.3%. Adding fuel to the better growth backdrop, the housing market is apparently roaring back to life. While residential construction was a big drag on Q1 GDP (falling 14.6% a.r.), sales and starts are rebounding. The big cities are reporting a snapback in activity—sales in Toronto were up 24.7% y/y, and prices are now barely down from a year ago.
Where does this leave the central banks? The firmer growth backdrop and a rebounding housing market will turn up the heat on the Bank of Canada. The odds of a rate hike at next week’s decision stepped back after a variety of Fed speakers openly favoured a June pause, but it’s still definitely a “live” meeting. While the Bank is perfectly happy to carve out a somewhat independent path, we suspect that they will opt to hold steady for now, but send a very loud message that their tightening bias is intact, and conditions are inflaming that bias. The Bank will have the luxury of only one more CPI report (on June 27) before their July 12 decision, but we now expect them to hike by 25 bps at that later meeting. For now, we are thus boosting our call by only that one extra quarter-point hike, with rates then likely to hold at 4.75% through the second half of the year.
In a similar vein, we are also bumping up our call on the Fed’s terminal rate by 25 bps to 5.25%-to-5.50%. However, at this point, we still expect a pause, or skip, at the mid-June meeting—assuming the CPI on the prior day is reasonably well-behaved. We suspect that after six weeks of deliberations the Fed will come to the conclusion in late July that the economy still has a bit too much momentum, and—more importantly—underlying inflation has too much staying power, and then hike one last time. After that, growth is expected to soften enough to then stay the Fed’s hand, and we continue to look for rate trims to commence in the first quarter of 2024.
Bottom Line: While the debt ceiling drama was hogging the headlines in recent weeks, the economy was quietly churning away, prompting an upgrade to both our calls on growth and the short-term interest rates. Circling back to the title of this piece, and paraphrasing Macklemore, the economy is still growing at a beat like we gave a little speed to a Great White Shark on Shark Week—i.e., too fast for central banks to rest for long.
In contrast to the high-side growth surprises in North America, an emerging theme in recent weeks is some disappointment on the pace of China’s recovery. From soggy retail sales and industrial production results for April a few weeks back, to this week’s slushy PMIs for May, there’s a sense that growth is stumbling. What’s also concerning is the lack of action on policy, particularly on the fiscal front. We would assert that it’s all about expectations—our view has long been that the hype around China’s reopening was overdone. To be sure, China will likely grow by more than 5.5% in 2023, and that has supported decent global growth this year. But any anticipation that this was going to fire up commodity prices looks woefully misplaced, especially since it’s services and domestic spending that have been revived, not outlays on goods. In fact, there's a wide array of commodity prices now well down so far in 2023, from nickel to corn, to oil and lumber, and to gas and copper.
Yet, while the near-term outlook for China’s economy may be a tad underwhelming, one shouldn’t miss the forest for the trees. We would note two factoids from this week that give a sense of just how rapidly the global economy is being remade by China’s relentless rise (and a counterpoint to The Economist’s recent cover story “Peak China”). First, China surpassed Japan in Q1 as the largest motor vehicle exporter in the world, with Germany in third place. Think about that one. Second, China conducted its first commercial flight of a large homegrown passenger jet this week. Thus, while Washington was busy struggling to avoid a self-inflicted economic injury on the debt ceiling, China’s economic heft continued to quietly advance by leaps and bounds.