What Do Strong Job Growth and Weak Wage Growth Mean for Our Mortgage Rates?

Last Friday we received the latest Canadian employment data and while the headline number came in a little lower than expected, the underlying details were encouraging.

Bluntly put, if you’re looking for mortgage-rate implications there is nothing in the latest data that would discourage the Bank of Canada (BoC) from increasing its policy rate by another 0.25% before the end of the year, which it is now widely expected to do. That said, there also weren’t any new indications that our average labour costs are increasing to a degree that would require the Bank to accelerate its rate-hike timetable further.

Here is a summary of the key details from the latest report:

Canadian Employment Highlights (for July)

• The Canadian economy added another 10,900 new jobs in July, which was slightly less than the 12,500 new jobs that the consensus had been expecting. While that number came up a little short, remember that our economy added an average of 50,000 new jobs over the prior two months and almost 400,000 new jobs over the prior twelve months.
• We added 35,100 new full-time positions and lost 24,300 part-time jobs last month, while average hours worked surged by 0.6% (on top of a 0.4% increase in June). That means that the quality of overall employment improved at the same time that the total demand for labour increased as well. Interestingly, almost all of the new jobs went to women aged 55 and older. This cohort added 14,000 new jobs in July and has added an impressive 66,000 new jobs over the most recent twelve months.
• Our overall unemployment rate dropped to 6.3% in July. This was down from 6.5% in June and marks its lowest level since October, 2008. Meanwhile, the participation rate, which measures the percentage of working-age citizens who are either employed or who are actively looking for work, fell from 65.9% to 65.7%. So the drop in the unemployment was caused partly by new job creation but also partly because more working-age Canadians withdrew from the labour force.
• Average hourly wages rose by 0.3% in July, on top of a 0.4% rise in June. Despite this recent uptick, average wages have still only risen by 1.3% over the last twelve months and as such, overall wage growth continues to lag the other economic data, most of which has shown marked improvement of late. This suggests that our economy still has room to grow before it reaches full employment, and before labour costs exert material upward pressure on our inflation rates. (And it also buys the BoC time to raise rates slowly if they are so inclined.)
• Our manufacturing sector added another 13,700 jobs in July. That is encouraging because new manufacturing jobs create a multiplier effect that triggers job growth across our broader economy and there is concern that the Loonie’s recent surge will hurt momentum in this vitally important sector. Thus far at least, the headwind from what the BoC calls the Loonie’s “competitiveness challenges” has not snuffed out our recent manufacturing-sector rally.

We also received the latest U.S. non-farm payroll data last Friday, and while the headline number came in a little higher than expected, the details showed that U.S. job creation continues to be more about quantity than quality.

Here are the highlights from that latest report:

U.S. Non-Farm Payroll Report (for July)

• The U.S. economy added an estimated 209,000 new jobs in July, which was more than the 183,000 jobs the consensus was expecting.
• The U.S. overall unemployment rate fell from 4.4% to 4.3% while the U.S. participation rate rose from 62.8% to 62.9%. That is noteworthy because it means that the U.S. economy is lowering its unemployment rate even as disenfranchised workers come off the sidelines and add themselves back in to the workforce. For most of the last decade, when the participation rate rose in a given month, the unemployment rate rose along with it, even if job creation was strong over the same period. If the rising participation rate no longer has this effect, it could be a sign that U.S. labour conditions are tightening.
• Average wages rose by 0.3% last month, up from 0.2% in June, but they continue to increase by only about 2.5% on a year-over-year basis. That growth rate is slightly higher than the growth rate for overall U.S. inflation (1.6%), but is still well below the 4%+ sustained wage growth that U.S. Fed Chair Janet Yellen has said will signal the U.S. labour market’s return to full health.
• While this report was roundly applauded, it should be noted that all of the new job growth was in part-time employment. The U.S. economy added a total of 393,000 part-time positions in July, led by 53,000 newly created jobs at restaurants and bars, while full-time employment fell by 54,000 jobs.
• Average hours worked also rose by a meagre 0.2% (down from 0.5% in June), so the decent headline number wasn’t supported by data that indicate any real uptick in either the quality of newly created jobs or in the overall demand for labour. That’s probably why the reaction of markets to the latest U.S. non-farm payroll report was subdued.

In summary then, the latest employment reports confirm that both the U.S. and Canadian economies are creating more jobs than they need to keep pace with the natural growth of their working-age populations. That said, the recent pace of job creation has not led to materially higher wages for the average worker and, more importantly, has not meaningfully expanded the average consumer’s purchasing power.

While it’s true that wages are a lagging indicator, meaning that it can take up to a year or more before increases in the demand for labour translate into higher wage costs, the current lag has lasted longer than expected and there is a growing belief that other factors, such as automation and the rise of just-in-time delivery systems, are partly responsible.

If those factors continue to help keep labour costs down, it may take longer than central bankers now expect for inflationary pressures to rise to levels that will warrant materially higher policy rates.

Five-year GoC bond yields fell ten basis points last week, closing at 1.54% on Friday. Five-year fixed-rate mortgages are still available at rates as low as 2.64%, and at rates as low as 2.79% for low-ratio buyers, depending on the size of their down payment and the purchase price of the property. Meanwhile, borrowers who are looking to refinance can find five-year fixed rates in the 3.04% to 3.09% range.

Five-year variable-rate mortgage discounts remain largely unchanged and are still available at rates as low as prime minus 0.90% (2.05% today) for high-ratio buyers, and at rates as low as prime minus 0.75% (2.20% today) for low-ratio buyers, again depending on the size of their down payment and the purchase price of the property. Borrowers who are looking to refinance should be able to find five-year variable rates around the prime minus 0.45% to 0.70% range, which works out to between 2.25% and 2.50% using today’s prime rate of 2.95%.

The Bottom Line: The latest Canadian and U.S. employment reports confirmed the continuation of two well-established trends: strong headline job creation and low average wage inflation. The strong headline job growth numbers probably bolster the BoC and Fed plans to raise their policy rates at least one more time in 2017 but the subdued growth in average wages should make both central banks reluctant to do much more than that.