indicatorThe Owl

Weekly Wrap October 27, 2023

The waiting is the hardest part: Economic fatigue setting in as inflation fight continues

By Mark Parsons, ATB Economics 27 October 2023 7 min read

In this week’s ATB Economics Weekly Wrap…

  • Bank of Canada in ‘wait and see’ mode
  • Canadian economy: Bumpy and soft
  • Oil prices and the war in the Middle East
  • U.S. economy just won’t quit
  • Chart of the week: What did you buy during COVID?

This week, we’re reminded of rock legend Tom Petty, who said “the waiting is the hardest part” in his classic song ‘The Waiting’. Though we don’t think he was talking about the lagged impacts of monetary tightening, the words ring true today. This week the Bank of Canada elected to wait and see if past rate hikes will be enough to steer the Canadian economy back to target inflation. The national economy looks to avoid a hard landing, but even a soft landing will feel rough for many.

Hike, pause…wait

Borrowers breathed a (small) sigh of relief on Wednesday when the Bank of Canada elected to forego another interest rate hike. But the Bank kept its hawkish, “prepared to raise the policy rate further,” warning alive.

The tension in the Bank of Canada’s policy ‘pause’ announcement was palpable. On the one hand, the Bank said inflation has been stubborn and progress slow. On the other hand, the Bank admits the Canadian economy is now stumbling from past rate hikes and that the ‘excess demand’ contributing to inflation is withering away.

To illustrate, here are quotes from the Bank of Canada’s statement under two competing themes:

1. Concerns about persistent inflation

“preferred measures of core inflation show little downward momentum”

“progress towards price stability is slow and inflationary risks have increased” 

2. Easing price pressures from the economic slowdown

“In Canada, there is growing evidence that past interest rate increases are dampening economic activity and relieving price pressures”

“[there are] clearer signs that monetary policy is moderating spending and relieving price pressures”

The Bank’s hawkish tone will carry the day until a clearer downward inflation trend is established. Our sense remains that another rate increase is the less likely outcome given theme #2 above. Our base case view is that the Bank is on hold until mid next year.

For more insight on the rate decision, check out this commentary from our interest rate team at ATB Capital Markets.

Canadian growth downgraded to ‘less soft’

It’s not the recession that seemed almost inevitable when inflation was peaking, but the Bank of Canada has downgraded its forecast for the national economy for both this year and 2024.

A downgrade to the growth outlook was a near certainty. Second quarter GDP growth (released after the Bank’s July forecast) was negative and the summer GDP and consumer spending numbers haven’t been great. The Bank lowered its forecast for real GDP growth this year to 1.2% from 1.8% in its July forecast, and to 0.9% (from 1.2%) next year.

The Bank is not anticipating a hard landing (i.e. recession), so let’s call it ‘less soft’. And in the press conference Tiff Macklem ruled out calling this episode stagflation: “Stagflation to me is a period of high inflation and high unemployment. That's not where we are now. Inflation is well above our target, it's too high. But it's not high like it was in the 70s.” That said, these growth prospects are quite weak and the near term inflation outlook has been revised higher. Even a soft landing will still be a bumpy ride for many Canadians and businesses.

The Bank of Canada’s Monetary Policy Report is typically silent on provinces. However, we can make some inferences based on industry-specific comments. In Alberta’s case, the Bank noted that energy-related investment is moving against the grain: “On the upside, investment in engineering structures is rising steadily, largely reflecting higher oil prices and major projects related to energy transportation. In contrast, investment in machinery and equipment has fallen by about 10%.” That fits with our view, reinforced by a recent ATB Capital Markets survey, that oil and gas investment will contribute to stronger growth in Alberta this year and next relative to other provinces. In other Alberta-related references, the Bank noted that the stalling of Canadian exports for the remainder of this year and next year is related to “softening demand for non-commodity exports” and sees the Trans Mountain Expansion (TMX) contributing to an eventual pick-up in exports.

The Bank of Canada is forecasting real GDP growth in Canada of 0.9% in 2024

The Bank of Canada is forecasting real GDP growth in Canada of 0.9% in 2024

Oil prices bouncing around, but not yet trending higher

Given the central role the region plays in global oil production, one might have expected oil prices to experience a sustained spike due to the increased uncertainty created by the Israel-Hamas war, but—so far at least—this has not been the case.

Three weeks into the Israel-Hamas war and, notwithstanding daily ups and downs, the reaction of crude markets has been relatively subdued. At US$86 per barrel, the average price of West Texas Intermediate (WTI) so far in October is lower than it was in September, with daily prices slightly higher than prior to the war. With that said, the situation on the ground in Israel and Gaza is highly unstable and the war could easily send oil prices higher for an extended period. At this point, we simply don’t know what will happen, but other factors such as growth concerns in Europe are weighing on oil markets. If the crude supply out of the region is perceived to be under major threat or is disrupted, a price jump can be expected.

The WTI oil price benchmark has averaged US$86 per barrel so far in October 2023

The WTI oil price benchmark has averaged US$86 per barrel so far in October 2023

U.S. GDP - third quarter lift off

Did that just happen? Yes, the U.S. economy grew at an annualized rate of 4.9% in the third quarter according to preliminary estimates. While growth is expected to moderate, the U.S. economy has (so far) been shrugging off higher rates and defying expectations.

The day after the Bank of Canada downgraded its Canadian growth forecast, we got news that the U.S. economy grew at its fastest clip since late 2021. Consumers led the charge, and it wasn’t just concert and theatre goers (for Swiftie fans, see our interesting fact below). Inventory builds and a rebound in residential investment also played a role. The U.S. economy has put together a string of five consecutive >2% (annualized) quarterly growth readings.

Overall, U.S. growth continues to defy expectations amid aggressive interest rate hikes. Case in point: the median 2023 forecast from U.S. Federal Reserve officials was 2.1% (Q4 to Q4) in September, up from 1% in June and only 0.4% in March. For the third quarter, the Philadelphia Reserve Bank forecast survey from August pegged growth at just 1.9%, though the GDP ‘nowcast’ from the Atlanta Fed came closer at 5.4%.

But don’t expect the current quarterly pace to continue. Income growth has eased and consumers continue to whittle down ‘excess savings’ from the pandemic (the savings rate dipped in Q3). A slowdown is expected next year. The Bank of Canada this week put U.S. real growth at 0.8% in 2024, compared to the International Monetary Fund’s October forecast of 1.5%.

The market continues to price in no change in the Federal Reserve’s target for the Fed funds rate at next week’s announcement (as of first thing this morning).

The U.S. economy is estimated to have grown at an annualized rate of 4.9% in the third quarter of 2023

The U.S. economy is estimated to have grown at an annualized rate of 4.9% in the third quarter of 2023

Interesting fact…Is Taylor Swift responsible for the surge in U.S. growth? Not exactly, but spending at concerts is providing a boost. According to a recent Bloomberg article, “The singer’s 53 U.S. concerts this year added $4.3 billion to the country’s gross domestic product, according to estimates from Bloomberg Economics.” Other analyses suggest that, taken together, the Taylor Swift and Beyonce concerts and the Barbie and Openhemier movies (‘Barbenhemier’) contributed $8.5 billion, or 0.6 percentage points, to third quarter (annualized) GDP growth in the U.S.

Chart of the Week:  What did you buy (or not buy) during COVID? New household spending data released last week tells us more about COVID spending patterns in Alberta. It’s dated (2021), but the granularity of the data is impressive and we feel warrants more attention.

I’m not sure if the chart will resonate with our readers, but it does with this author (yes, I bought a bike in 2021). This is more than just interesting, it’s also helpful for understanding current trends and predicting the future. Spending on services has been playing catch up (so-called ‘revenge’ spending). Now that households have upgraded their home entertainment system, they are dining out and spending more on in-person entertainment. For example, as we’ve noted, spending at restaurants and bars has far outpaced sales growth at food and beverage retail outlets this year. Looking ahead, with higher interest rates biting, the Bank of Canada’s survey of consumer expectations indicates that Canadians have expressed more willingness to spend on vacations and concerts than big ticket goods purchases typically financed by loans.

There were some dramatic changes in average household spending patterns during the COVID-19 pandemic

There were some dramatic changes in average household spending patterns during the COVID-19 pandemic

Daily trivia

Answer to the previous trivia question: At about 20% of the global total, the United States consumes the most crude oil per day.

Today’s trivia question: The first game of the World Series is scheduled for tonight (October 27). Which two teams are vying for the championship?

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