The secret's out: all the recent monetary tightening might not cut it, especially in light of today's jaw-dropping job growth statistics.
Relax, though; central banks say, "Just hold on." "Monetary policy needs time," they remind us—a bit like waiting for a 90s video to buffer.
However, it's worth noting that these same central bankers have limited influence over two significant factors fueling today's robust employment figures: fiscal and immigration policies (we'll delve into these shortly).
Investors have been in a state of anticipation for several months, anticipating an economic downturn in North America. Judging by the recent labor statistics in both Canada and the United States, it appears they might be on the verge of disappointment. It's evident that there is still significant work to be accomplished.
The Key Takeaways
In the wake of this morning's employment surprise, bond yields surged during early trading, and while they've retraced somewhat, the reports overall lean more towards optimism than pessimism for fixed mortgage rates. In Canada
Jobs Added: +63,800 (versus an estimated +20,000)
Wages: Increased by 5.0% year-over-year
Unemployment Rate: 5.5% (versus an estimated 5.6%)
Recap: The increase in educational services jobs and part-time employment (+47.9k) skewed this month's figures. However, seasonally adjusted wage gains dropped from 0.5% month-on-month to 0.2%. This suggests that the underlying job trend might be weaker than initially perceived.
In the U.S.
Jobs Added: +336,000 (versus an estimated +170,000), with an additional +119,000 in July/August revisions.
Wages: Increased by 4.2% year-over-year, a slight decrease from 4.3%.
Unemployment Rate: 3.8% (versus an estimated 5.6%)
Recap: The U.S. economy is gaining momentum, recording its largest job gain since January (during which the 10-year Treasury rate increased by 60 basis points in 30 days). Fortunately, the most critical element of job numbers, wage growth, is currently at its slowest pace since mid-2021.
According to BMO Chief Economist Doug Porter, today's data "is unlikely to tip the scales for the Bank of Canada." However, he notes that "it will maintain their bias towards tightening." This assessment aligns with the consensus among most economists.
Following the release of the employment data, yields saw significant double-digit surges, although they have subsequently stabilized.
At the moment of writing, Canada's 4-year swap rate (as shown in the chart below) had increased by approximately 6 basis points in response to the news.
The benchmark 5-year yield for Canada Mortgage Bonds (CMB) (as illustrated in the chart below) also experienced a comparable increase, reaching new multi-year highs.
Insured mortgage rates have a strong correlation with CMB yields. Therefore, if this trend continues, there might be upward pressure on insured rates, especially from lenders who haven't revised their pricing recently.
In terms of the lowest nationally advertised insured rates, they have already increased by 10 bps in recent days, currently standing at 5.64% for a 5-year fixed mortgage. This is approximately 94 bps higher than the 5-year CMB yield, aligning with the long-term average difference of around 90 bps.
Probabilities at the Central Bank
In the OIS market, there's a 69% implied probability that we might receive a rate hike for Christmas instead of an ugly sweater. Furthermore, it appears that one is almost entirely factored in by March (refer to the table below).
In the U.S., futures indicate only a 31% probability of the Fed raising its key lending rate at its November 1 meeting.
It's important to note that these probabilities are tempered compared to a scenario where bond yields hadn't surged in the last three weeks. The increase in yields is effectively tightening financial conditions, which is contributing to some of the work that the BoC and Fed typically do through their rate hikes. In fact, yields might have an even more substantial impact on the economy than central bank rate hikes, according to Desjardins rate strategist Royce Mendes in a recent report.
The decision of whether North American central banks will further increase borrowing costs largely depends on the upcoming Consumer Price Index (CPI) reports. We'll receive these crucial numbers on October 12 in the U.S. and October 17 in Canada.
The Big Picture
Renowned bond expert Mohamed El-Erian shared his insights on the Fed during a recent appearance on Bloomberg, and his perspective is quite telling: "When you fall behind right at the beginning of an inflation cycle, you pay the price when you get to the last mile." This observation particularly applies to the current employment situation.
Adding to the complexity is the fact that central banks lack a willing partner at the federal government level. The battle against inflation is receiving minimal support from politicians who have approved an unprecedented $360 billion in Canada and $5.1 trillion in the U.S. for Covid-related spending. Furthermore, they continue to fan the flames of inflation with additional unnecessary deficits.
The question arises: How can you rein in a $27 trillion U.S. economy that's already near full employment when you're pumping it with deficits totaling approximately $1.5 trillion in 2023 (equivalent to about 6% of GDP, including public debt charges), plus an additional $1 trillion from the previous year?
To some, U.S. inflation may appear to be solely an American concern. However, that's not the case. It's spilling over our border and exacerbating price increases in Canada, leaving Canadian mortgage holders to deal with the aftermath.
Returning to the topic of employment
"That's entirely incorrect. The true detriment to workers is inflation. We have a century's worth of historical evidence supporting that."
—Former BoC Governor, David Dodge, refuting claims against raising the unemployment rate (FP)
Canada's expanding labor pool could potentially alleviate inflationary tensions stemming from a tight job market. However, this doesn't address the short-term impact of population growth on inflation. Currently, we're not witnessing a rapid increase in unemployment or a swift decline in wage growth.
For individuals managing mortgages, the situation can be likened to waiting for an elusive event, much like the characters in Samuel Beckett's play "Waiting for Godot." Rate relief appears to be several months away, and it might necessitate tighter monetary policies before it materializes.
Borrowers have no alternative but to prepare for a turbulent conclusion to Q4. The coming months could resemble a challenging marathon, with more discouraging inflation data on the horizon.
On a more positive note, oil prices seem to be cooperating, with WTI crude experiencing an unusually steep 13% decline over the past six trading days (see chart below).
This increases the probability of a more favorable inflation figure for October. (October's CPI data is scheduled for release in November — and it will incorporate a favorable monthly inflation comparison.)
Looking towards 2024, as there's a glimmer of hope on the horizon. Historical trends (refer to the chart below) indicate that low unemployment isn't sustainable when real interest rates are at these elevated levels. They have historically exhibited an inverse correlation during economic slowdowns.
Well, perhaps those wise central bankers are onto something when they recommend patience until the middle or end of 2024. But if you're a borrower feeling as taut as a drumhead, hearing that advice is easier said than done.
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The financial landscape is becoming increasingly complex, and mortgage decisions are more critical than ever. Whether you're a first-time homebuyer, considering a mortgage renewal, or simply want to explore your options in these turbulent times, you don't have to go it alone.