September 01, 2023 | 13:23
Out of Summer, Out of Sync
When we officially dropped our U.S. recession call a number of weeks back, we studiously and purposely did not do the same for Canada—that is, we still had two quarters of modest GDP declines in our forecast for the northern economy. The logic behind the mild divergence between the two was driven by Canada’s much heavier debt load, and a less forceful fiscal thrust than stateside. This week’s round of data suggests that the U.S./Canada divergence may have been something more than “mild” in the summer… especially for consumers. And, it also reinforced the very real risk that Canada is heading for a shallow contraction, even with rollicking population growth.
Friday’s headline data releases vividly highlighted the economic divergence, as U.S. jobs kept plugging along in August while Canadian GDP surprisingly fell in Q2 and started Q3 soft. The 187,000 U.S. payroll rise was a tad above expectations, but was paired with downward revisions to earlier months, so it didn’t really change the big-picture view that growth stayed firm in the summer. A 0.4% rise in aggregate hours worked provided additional evidence, and even the 3-tick jump in the jobless rate to 3.8% was driven by a surge in the participation rate. Even the factory ISM reading of 47.6 for August was a bit better than expected, completing a circle of reasonably robust economic data through the summer. While we doubt that GDP will live up to the still-strong Atlanta Fed’s Nowcast of 5.6% for Q3, we bumped up our call to 2.9% this week amid the steady show of strength.
In stark contrast, Canada saw a stream of softness in the real GDP report. Of course, the shocker was the 0.2% annualized dip in Q2 activity, especially when consensus was looking for a 1.2% advance, and the BoC had pencilled in 1.5% growth for the quarter. Standing back, it’s really not that stunning that GDP contracted given a massive civil servant strike, numerous wildfires that crimped oil production, and some inevitable giveback from Q1’s surprising strength. And recall that GDP also dipped—surprisingly—in the fourth quarter of last year, so quarterly declines aren’t that rare. We expect this stop-start pattern to continue in coming quarters; even with a soggy start, we look for modest 0.3% growth in Q3 (still well below our U.S. call), before another small contraction in Q4. As a result, we now look for just 1.1% GDP growth for all of 2023 (down from 1.6%) and 0.6% next year (from 0.8%).
The big story in Canada’s deep Q2 slowdown was a dramatic braking in the consumer. And this is a theme well worth highlighting, given the prominence that the BoC gave to consumer spending in its past two rate decisions. In the Statement following each of the June and July rate hikes, the Bank noted that real spending had powered ahead at a sizzling 5.7% annual rate in Q1, which was simply too strong for comfort and suggested the consumer was readily handling higher rates and high inflation. To these eyes, it seemed reasonably clear that the strength was a flash in the pan, due to a mild winter and the boost from special government support payments, which would fade fast. Warnings from some large Canadian retailers flagged that things had soured abruptly in Q2. And sure enough, not only was Q1 revised down a full point to 4.7% in Friday’s release, but Q2 came in at a very modest +0.2%. This yanked down the yearly growth rate to a mild 1.6% y/y clip, which a) shouldn’t scare anyone, b) is half of population growth, and c) compares with 3.0% y/y real spending growth in the U.S. as of July (Chart 1).
The weak GDP report lands like a thud just days ahead of the Bank of Canada’s next rate decision. While a heavy CPI result for July threw a bit of doubt into the proceedings, we believe the case for the Bank to pause is now overwhelming. Between the half-point rise in the unemployment rate in the past three months—a clear and present warning sign—and the big slowdown in GDP, it’s quite apparent that past rate hikes are now weighing heavily on households, and that it’s a matter of time until that translates into cooler underlying inflation trends.
A few mild complications for the Bank, and reasons we can’t definitively say that rate hikes are completely done:
Even so, the deep cooldown in Q2 growth, and the likelihood that activity will remain soggy in the second half of the year, should overwhelm these temporary complications. The prudent course of action for the Bank would be to now move to the sidelines and let the much chillier growth backdrop work its way through the underlying inflation picture. That undoubtedly painfully slow process is a good reason to believe that the shift to rate cuts is still a long way down the line.