Why CDN Bond Yields Didn’t React To Our Latest Employment Surge

We received the latest Canadian employment report last week, and it showed a surprising surge in job creation. Our economy grew by a whopping 74,000 jobs in September, more than tripling the consensus estimate of 20,000 new jobs which were forecast for the month.

Government of Canada (GoC) bond yields would normally be expected to rise in response to a sharp increase in employment demand. Rising demand pushes labour costs higher over time, and the cost of labour is a key driver of broader inflation. But five-year GoC bond yields actually fell slightly on Friday after the latest employment data were released. While this may not seem intuitive, a closer look at the employment data will help us to better understand the market’s reaction:

• Our employment data have been unusually volatile over the last year, with stronger-than-expected job growth months followed by weaker-than-expected job growth months. Take a look at our employment totals over the most recent six months: September (+74,000), August (-11,000), July (+42,000), June (-9,400), May (+25,800), April (-29,000). Against this backdrop the market will rightly look past the monthly noise towards longer-term employment growth trends. To that end, we have averaged 13,000 new jobs per month over the last year, which is less than the estimated 20,000 new jobs per month that we need just to keep pace with our population growth. In that context, the market’s collective shrug at the latest surge in the employment data makes more sense.
• Our unemployment rate fell from 7.0% to 6.8% in September, and it now stands at its lowest level since December, 2008. Meanwhile, our participation rate, which measures the percentage of working-age Canadians who are either employed or actively looking for work, still hovers at 66%, which is the lowest it has been since 2001. This strange disconnect has spawned a debate about whether today’s ultra-low participation rate has been caused by cyclical or structural factors. If Canadians have withdrawn from the labour force because of cyclical factors, such as a lack of employment opportunities, then an improving economy should bring these disenfranchised people back into the labour force. And this pent up supply of available workers would act as a buffer against any significant upward pressure on our labour costs for some time to come. Conversely, if the withdrawal of so many Canadians from our labour force is a result of structural factors, such as demographic changes or a lack of the requisite skills required by today’s employers, then there will be far fewer qualified workers for our economy to absorb. In this scenario, any material improvement in our economic prospects will push up our labour costs, and overall inflation, much more quickly than expected. For now, the cyclical-versus-structural debate about what is underpinning the phenomenon of an ultra-low unemployment rate alongside an ultra-low participation rate rages on. Frankly, there wasn’t enough in last month’s employment data to move observers definitively to either side of that argument.
• Average hourly earnings rose by 1.4% for the month, and by 2.1% on a year-over-year basis. This rate of earnings growth is identical to our inflation growth rate of 2.1% over the same period, as measured by Statistic Canada’s Consumer Price Index (CPI). Put another way, there has been no change in the purchasing power of the average Canadian worker over the past year, and we shouldn’t expect to see an improvement in our economic momentum for as long as that is the case.
• Our labour market is made up of private, public and self-employed workers. Of the three, strong growth in private sector employment is seen as the healthiest signal, and the private sector created a staggering 124,000 new jobs in September. But here again, this strong result follows the loss of 112,000 private sector jobs in August, and that explains why the market held its applause.

The most relevant question for Canadian mortgage borrowers is how our latest employment data ties into evolving monetary-policy narrative at the Bank of Canada (BoC). Despite the strong headline number, the latest results aren’t expected to have any material impact on the BoC’s neutral monetary-policy stance.

BoC Governor Poloz has repeatedly predicted that it will take some time for our output gap, which measures the difference between the actual output of our economy and its maximum potential output, to close. He has also made it clear that the Bank has no concerns about lagging the U.S. Federal Reserve when it starts raising short-term U.S. rates, which it is now expected to start doing in mid-2015. Against that backdrop, it will take a lot more than one upside surprise in our volatile employment data to get the market’s attention.

Five-year GoC bond yields fell seven basis points last week, closing at 1.52% on Friday. Five-year fixed-rate mortgages are available in the 2.79% to 2.89% range, and five-year fixed-rate pre-approvals are offered at 2.99%.

Five-year variable-rate mortgages are available in the prime minus 0.65% to prime minus 0.80% range, depending on the terms and conditions that are important to you.

The Bottom Line: Investors effectively brushed off the latest Canadian employment data, despite the strong headline number. For the reasons outline above, I think it will take several consecutive months of above-trend employment growth before it has any material impact on bond yields and/or the BoC’s current monetary-policy path.