Running But Not EmptySeptember 29, 2014
Why CDN Bond Yields Didn’t React To Our Latest Employment SurgeOctober 14, 2014
Once again though, beauty is in the eye of the beholder.
Those who think that the U.S. economy is well on its way to recovery noted that it has now created an average of 224,000 new jobs per month over the last three months. This run rate is well above the 150,000 new jobs that U.S. economy must create in order to keep pace with U.S. population growth and the natural expansion of the U.S. labour force. Furthermore, all of the pickup was in full-time positions, where 671,000 new jobs were added, while part-time positions fell by 384,000. The broader U6 unemployment rate, which includes part-time workers who would prefer to work full time, fell once again from 12% to 11.8%, and the average workweek expanded to 34.6 hours, the highest it has been since the start of the Great Recession. David Rosenberg noted that this expansion in hours worked was equivalent to adding another 400,000 new jobs to the U.S. labour force. If this trend continues, U.S. employers will be forced to create more jobs because their existing employment base can only be stretched so far.
Those who think that the recent improvement in the U.S. employment data leaves more to be desired also found fodder for maintaining that belief in the September data. The U.S. participation rate, which measures the percentage of working-age Americans who are either employed or actively looking for work, fell to 62.7%. This marks the lowest level for the participation rate since February 1978. Average earnings were also flat for the month, and U.S. wage growth has averaged only 2% on an annualized basis over the most recent twelve months. This is barely above the average U.S. inflation rate of 1.7% over roughly the same period. The U.S. recovery cannot sustain healthy momentum without rising consumer demand, and that’s hard to envision without a material rise in the average American’s purchasing power.
At its most basic level, today’s evolving debate between bulls and bears over the state of the U.S. economic recovery comes down to the question of whether the unemployment rate or the participation rate provides the more accurate gauge of the health of the U.S. labour market.
The U.S. Federal Reserve continues to take the position that the ultra-low U.S. participation rate is being caused by cyclical economic headwinds which can be partially offset by stimulative monetary policies. The primary support for this argument is that average earnings remain flat, even in the face of rising employment demand.
Conversely, a growing number of market watchers believe that the U.S. labour market is shrinking because of structural factors, such as demographic changes and skills mismatches which are unaffected by monetary policy stimuli. They point to more detailed employment data, such as rising voluntary quit rates and a fall in the average duration of unemployment. This camp also argues that average wages are a lagging indicator, and that the Fed will therefore keep monetary policy loose for too long if it waits until wages rise before starting to increase its policy rate.
The latest U.S. employment data do not appear to have meaningfully altered the market’s view on the timing of the Fed’s next short-term rate increase, which is still estimated to occur in the mid-2015 time frame. But current momentum favours the view that the Fed is more likely to tighten sooner than expected and each new positive economic data release bolsters that belief. Frankly, I was surprised that markets didn’t react more bullishly to the report, but perhaps that is because there are other variables, such as the wobbly economies outside of the U.S, which tempered their enthusiasm.
From a Canadian perspective, if the sooner-than-expected view on the timing of the Fed’s next rate increase continues to gain traction, we can expect U.S. bond yields to rise. This would normally push Government of Canada (GoC) bond yields higher in sympathy because of the very high correlation between the two, but that historical relationship may not hold. Bank of Canada (BoC) Governor Stephen Poloz has repeatedly said that the BoC will not follow the Fed’s tightening timetable in lock step, and markets appear to believe him, in part because the BoC’s overnight rate currently sits at 1% whereas the Fed’s equivalent policy rate hovers at 0%. Thus, at the very least, Governor Poloz has the luxury of letting the Fed’s policy rate move closer to the BoC’s policy rate.
Five-year GoC bond yields fell four basis points last week, closing at 1.59% 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 rates in the 2.99% to 2.94% range.
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: The market reaction to the latest U.S. employment data was muted, but I expect U.S. bond yields to rise if new U.S. economic data continue to show incremental improvement. While that would normally push Canadian bond yields higher in sympathy, BoC Governor Poloz has made it clear that Canada will forge a somewhat independent monetary policy path, and the current gap between our respective policy rates gives his guidance added credibility. If markets continue to believe him, Governor Poloz’s stance should give Canadian mortgage rates a buffer against rising U.S. bond yields.