June 4, 2024 | Easing Begins as Unemployment Rises

We’ve long noted that their actions tend to be contagious once central banks start easing rates in response to disinflation and weakening global demand.

This week, the Bank of Canada (BOC) and European Central Bank are expected to follow the Swiss and Swedish central banks in announcing the first 25 basis point (bps) cut since the latest great tightening cycle began 27 months ago in March 2022.

The BOC’s fear of reviving housing speculation and weakening the loonie is expected to restrain this cycle’s speed and depth of cuts. That will depend on the job market.

Policy plans are premised on a relatively modest increase in the Canadian unemployment rate to 6.6% by year-end and a drop back to 6% in 2025. If the economy contracts, those bets will likely be off, and the BOC will want to move more aggressively than it is presently presumed. Still, there’s no quick fix; policy changes take quarters to filter through economies.

Canadian unemployment has risen 130 bps from 4.8% in July 2022 to 6.1% in March and 6.2% expected in May. Historically, when Canadian unemployment has risen 80 bps from the cycle low, a recession is already underway, and the unemployment rate accelerates well into the subsequent recovery phase while central banks slash policy rates.

The downside risk is magnified by an economy burdened with non-productive debt, unaffordable home prices, and engorged stock and corporate debt prices. As the BOC noted in its May 2024 financial stability report: “Stretched asset valuations may not properly reflect risks to the economic outlook and therefore increase the likelihood of a disorderly price correction.”

Last week, Stascan slashed its second estimate for Canada’s fourth-quarter GDP from 1% to 0.1%, and the first-quarter 2024 estimate was lowered to 1.7% from 2.2%. First-quarter US GDP growth was also revised down to an annualized 1.3% from an earlier estimate of 1.6%, mainly driven by a consumption estimate reduction.

This week, we will receive several widely followed measures on the US job market, culminating on Friday with the latest Non-farm payroll guestimate (consensus at +195,000 in May). As noted by the Wall Street Journal, The Fed may soon have more to worry about than just inflation:

“In short, signs of a slowdown are becoming hard to ignore. This may not start to influence the calculations of the Fed until it shows up more strongly in the monthly payroll numbers. Those showed some slowing in April but, at 175,000 jobs added, was still decent. The report on May will be released on Friday.

But developments in the labor market are a lagging indicator, meaning they show up later than other signs when an economic shift occurs. The early signals are already here.”

Danielle Park June 4th, 2024

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