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April 15, 2013
The latest Canadian and U.S. employment reports were released last Friday and the data in both came in well below expectations.
U.S. and Canadian employment data should always be counted among the most important economic indicators for anyone keeping an eye on where Canadian mortgage rates are headed. In normal times, this is primarily because rising labour costs have an 80%+ correlation with rising inflation which then leads to higher mortgage rates. But in today’s world, the employment data in both countries take on an even greater significance. Here’s why:
- The U.S. Federal Reserve has stated that it will continue its current quantitative easing programs until U.S. unemployment reaches 6.50%, provided that U.S. inflation does not exceed 2.50%. (This unconventional and unprecedented level of monetary stimulus adds $85 billion to the U.S. Fed’s already bloated balance sheet each month.)
- Canadian Federal Finance Minister Jim Flaherty has said that the Bank of Canada’s near-term monetary-policy objectives should also be focused primarily on job growth. He introduced the term “flexible-inflation targeting” when explaining that short-term interest rates should be allowed to remain at ultra-low levels, even if that means letting the Consumer Price Index (CPI) temporarily rise beyond its 1% to 3% target range over the short term. Our recent inflation data don’t indicate that we will exceed this target any time soon, but Mr. Flaherty’s comments on the subject confirm that Canada’s near-term monetary-policy objectives are also focused on employment growth above all else.
Now that we have reaffirmed the importance of the employment data in both Canada and the U.S., let’s take a closer look at what was in the latest reports and draw out some of the implications:
The March U.S. Nonfarm Payroll Report
The U.S. economy added only 88,000 new jobs in March. To put that number in perspective, the U.S. economy needs to create 150,000 new jobs each month just to keep pace with its population growth and it needs to average 200,000+ new jobs per month over an extended period to reach the U.S. Federal Reserve’s goal of 6.50% unemployment – at least in the way that was intended.
I say that because the U.S. unemployment rate actually fell from 7.70% to 7.60% in March, technically bringing the U.S. Fed closer to its 6.50% goal. But that was because the U.S. participation rate (which measures the number of Americans who are either employed or are actively looking for work) fell from 63.5% to 63.3%. This drop was the result of 496,000 more Americans disengaging from the labour market in March, bringing the U.S. participation rate down to its lowest level in thirty years.
So what are the 90 million Americans who have withdrawn from the U.S. labour force doing? Many have borrowed to go back to school to upgrade their skills, which the U.S. government is actively encouraging, and in theory at least, for good reason.
Most readers will be surprised to learn that many U.S. companies are complaining that there aren’t enough skilled workers to fill their job openings. In fact, U.S. job openings have risen to their highest level since the start of the Great Recession and over the past twelve months, the U.S. economy has seen six new job openings for each newly filled position. This has the makings of the perfect storm – a shortage of skilled workers that drives up the cost of labour (triggering “cost-push inflation”) combined with a record number of under-qualified, unemployed Americans who exert a heavy drag on the U.S.’s overall economic momentum. This high inflation, low growth scenario is called stagflation – and it is one the U.S. federal government wants to avoid at all costs.
To combat this developing trend, the U.S. government has facilitated a huge increase in student lending. Overall U.S. student debt now hits new record highs on a monthly basis and unfortunately has record default levels to match. This is the next U.S. credit bubble still in the making, a by-product of excess liquidity and of the federal government’s desire to implement policies that should theoretically address the rising threat of stagflation. But as with many (most) government policies that are implemented on such a massive scale, the original intent is being lost in a wave of misallocation, over borrowing and outright abuse.
If out-of-work Americans were being trained to fill the same highly skilled positions that today sit vacant at many U.S. companies, aggressive student-loan lending would be justified. But the mostly young Americans who are borrowing to fund their expensive educations will leave school saddled with record debt levels and enter a labour market that pays relatively little for the skills that most of them can offer. For example, the U.S. education system is still graduating too many marketing specialists and not enough engineers. If that skills gap remains, all that record student lending will do is create more economically vulnerable Americans who are ill-prepared for more tough times ahead.
Most of these same young and already over-indebted Americans are in the heart of today’s first-time home-buyers cohort and that’s why I remain skeptical about claims that the U.S. economic recovery is now on a more stable footing. Any such theory seems to be based in large part on the belief that the U.S. housing market is in full recovery mode, but the rebound in U.S. house prices has been primarily fueled by investors who are taking advantage of unmet demand for rental properties. Those renters are the same would be first-time buyers who remain noticeably absent from the housing rebound. Until they enter the housing market, we won’t see the kind of organic housing demand that a healthy economic recovery requires to sustain itself over the long term. And that won’t happen until young Americans enjoy far brighter job prospects than they do today.
Canada’s March Labour Force Survey
The Canadian employment data have been confounding economists for some time because our recent of record of robust job growth has not been supported by any of our other major economic indicators. As I have written in past posts on this subject, eventually either our economic growth has to pick up, or our rate of job creation has to slow, or even contract.
Our latest employment report confirmed the latter, indicating that our economy lost 54,000 jobs in March.
The private sector was the hardest hit, shedding 85,400 jobs for the month and marking the largest one-month decline since we started tracking these data in 1976. Of this number, the manufacturing sector lost another 24,200 jobs, bringing its cumulative decline over the past three months to 71,400. Remember that manufacturing jobs are especially important because they produce a powerful multiplier effect that spreads throughout the broader economy. (This was highlighted in a report by the Department of Finance last year which estimated that each manufacturing job in the automotive industry produces 3.6 other jobs, 2.4 of which are in non-manufacturing sectors.)
On an overall basis, our economy has now lost a total of 26,000 jobs so far this year. While that is discouraging, the employment picture in Canada is still far healthier than in the U.S. We have long since recovered all of the jobs that were lost since the start of the Great Recession, unlike in the U.S. where that goal remains a long way off. When differences in the way our unemployment rates are taken into account, Canadian unemployment levels are still significantly lower.
That said, our economic momentum is still slowing and important questions about the sustainability of our recovery remain.
While the federal government’s just released budget shows the kind of restraint that debt-rating agency analysts will admire, is its austerity-light theme appropriate for our current economic circumstances?
Although our federal government’s decisions not to engage in seemingly reckless quantitative easing programs or the beggar-thy-neighbour currency wars that are escalating beyond our borders are still prudent long-term policy decisions, how will the export-led sectors of our economy cope in the meantime?
If businesses are reluctant to invest in the face of so much uncertainty and if government spending initiatives designed to provide short-term economic stimulus aren’t on the horizon, are we really pinning our hopes on the already over-indebted Canadian consumer?
Lastly, In light of all of these troubling questions, how can the Bank of Canada still maintain its tightening bias with a straight face?
Five-year Government of Canada (GoC) bond yields fell seven basis points last week and closed at 1.23% last Friday. Five-year fixed rates are offered at well below 3% and ten-year fixed rates at well below 4%. The vast majority of borrowers are still opting for five-year fixed-rate mortgages and as such, should pay very special attention to the differences in the terms and conditions offered by different lenders. For example, while fixed-rate competition between lenders is spring-market tight, there are still huge differences in the way lenders calculate fixed-rate mortgage penalties (Hint: Watch out for Canada’s Big Six banks who exclusively use the “Discount Rate” and “Posted Rate” IRD penalty methods described in my post link above.)
Five-year variable rates are offered in the prime minus .40% to .45% range (which works out to 2.60% to 2.55% using today’s prime rate).
The Bottom Line: The March employment data for both Canada and the U.S. confirm that there is still only sputtering economic momentum in both countries. The latest reports continued to stoke uncertainty about the future and this further increased investor demand for safe-haven assets like GoC bonds. This in turn drove GoC bond yields down again last week, to the benefit of Canadian mortgage borrowers everywhere.