United States Highlights
- The first full week of the second quarter was sparse on economic data. The services sector showed signs of modest acceleration, while vehicle sales fell for the second straight month in March.
- Minutes from the March meeting of the Federal Open Market Committee (FOMC) reiterated members’ unwavering commitment to act quickly to restore price stability.
- The minutes provided a blueprint for the Fed’s balance sheet runoff, which will be more aggressive and accelerate faster than before. At such a rate, the second round should end at the end of 2024.
- Economic news has been nonstop this week, from the business outlook survey to the federal budget and other jobs numbers.
- The labor market continues to tighten, with the unemployment rate hitting a series low of 5.3%. Wage growth is accelerating but remains slightly below that of the second half of 2019.
- Combined with a strong business climate and a stable federal fiscal situation, all systems are opting for a rate hike next week. Given inflation and economic strength, a 50 basis point move is warranted.
United States – The Fed’s Most Important Task
The first full week of the second quarter was sparse on economic data. On Tuesday, the Institute for Supply Management released its services report which provided signs of a modest pick-up in economic activity in the sector. Yet the report was full of contrasting elements. On the one hand, demand indicators were higher with business activity, and new domestic and export orders increased over the month. This was likely supported by an increase in employment and the recent improvement in delivery times allowing companies to replenish their depleted stocks.
On the other hand, the imports sub-index fell into contractionary territory while ongoing supply chain emissions lowered purchasing managers’ inventory sentiment to an all-time low. The price paid indicator was unsurprisingly higher given the energy shock caused by the Russian-Ukrainian war, with all 18 industries posting higher prices (Chart 1). Additionally, feedback from respondents was quite negative, reflecting pessimism about rising costs and continued supply chain disruption.
This pessimism was echoed in the vehicle sales release, which showed the second straight month of declines in March. While underlying demand remains strong and improving, sales will remain constrained by limited inventory. In addition, production could suffer another blow if the war in Ukraine leads to a shortage of semiconductors later in the year. Due to strong demand and tight supply, the inventory-to-sales ratio – a measure of the adequacy of supply relative to current demand – remains historically low. This will continue to put upward pressure on car prices in the near term.
Tackling lingering price pressures remains the Fed’s most important task. Minutes from the March meeting of the Federal Open Market Committee (FOMC) reiterated the members’ unwavering commitment to move quickly to restore price stability and reach a neutral policy stance by the end of the year. Many participants expressed their concerns about the inflationary risk and expressed their preference for a 50 basis point tightening of the key rate at the next meeting on May 3 and 4.
Chart 2 shows the dollar amount of US Treasury bills maturing (in billions) in the System Open Market Account (SOMA) from March 2022 to December 2024, as well as the series of monthly caps from the previous liquidation cycle of 2017 -2019 and the one expected this time. In the previous cycle, the Fed limited caps to $6 billion per month, steadily increasing the level to $30 billion over a 12-month period, then dropping it to $15 billion in 2019. This time, the Fed is expected to phase in three months to reach the cap of $60 billion, double the maximum size of the previous runoff cycle.
The minutes also provided a blueprint for the Fed’s balance sheet runoff (aka Quantitative Tightening or QT). As we wrote in this report, the monthly ceilings will be larger than during the previous QT cycle, amplified by the rise in asset holdings (Chart 2). Participants agreed to shed $60 billion of Treasury securities and about $35 billion of agency MBS per month, but the transition period will be shorter than expected, at just three months. The runoff could start as early as May, suggesting the balance sheet could shrink by $2.7 trillion by the end of 2024. By then, we expect the Fed to hit $1.7 trillion in reservations – the level of reservations “consistent with the Committee’s broad reservations operating framework”.
Bond markets reacted by selling longer dated US Treasuries, causing the yield curve to steepen. At the time of writing, the 10-year Treasury yield was 2.69%, up 0.3 percentage points from its close last week.
Canada – Upcoming rate increases
Economic news has been nonstop this week, from the business outlook survey to the federal budget and other jobs numbers. All in all, there was nothing in all of this to give the Bank of Canada pause before raising rates by half a point next Wednesday.
The Bank of Canada’s Business Outlook Survey found that businesses remained somewhat optimistic about the outlook. Investment intentions remained high and labor markets remained tight – a problem for businesses, but a sign of a healthy economy. The survey was largely conducted before Russia invaded Ukraine, although a recent special survey indicated, unsurprisingly, that companies expect the war to add to inflationary pressures by increasing input costs. The less publicized parallel survey of consumer expectations echoed the same themes: strong labor markets and inflation concerns. However, spending intentions remained strong and the likelihood of people leaving their jobs next year peaked at 22%.
One economic actor that inflation helps is the federal government, where higher inflation has improved the fiscal outlook presented in Budget 2022 compared to what was presented in the Fall Economic Statement (see analysis). However, the budget does not turn black again over the forecast horizon, thanks to nearly $60 billion in additional spending (graph 1). The federal debt-to-GDP ratio, however, remains on a downward trajectory due to a growing economy.
The new spending measures were split between priorities relating to housing, climate and environmental action, childcare, defence, dental care and measures to foster reconciliation with Indigenous peoples. Revenue-boosting measures have been targeted: a tax on large financial institutions and increased efforts to close tax loopholes are expected to generate $17 billion over five years.
To cap off the week, March employment data revealed that the Canadian labor market shows no signs of slowing down, with 73,000 new jobs created. The unemployment rate fell further, to 5.3% – the lowest level since comparable data became available in 1976. Unsurprisingly, wage growth also accelerated, with growth in the average hourly wage up 3.4% from a year ago. If we abstract out wage distortions during the pandemic – with job losses having been skewed towards lower wage positions, raising the average – wage growth is still not as strong as it is. was at the end of 2019. Wage growth is also not keeping up with inflation, which was 5.7% y/y in February. But, with such a tight labor market, wage growth is bound to accelerate.
The Bank of Canada is expected to raise its rates by 50 basis points next Wednesday. It would be an aggressive move by the Bank, which has only risen 25 basis points over the past 20 years. Given the hot economy, the move is warranted.