Analyst still sees a slowdown in the numbers, noting negative real job growth, still predicts cuts
December’s jobs report pointed to a Canadian economy on the downswing, but with enough bright spots and aberrations to give investors pause. The narrative going into 2024 was that both the Canadian and US economies would slow down, Canada may dip into a recession, and the central banks would begin to cut interest rates. The Bank of Canada was predicted to cut interest rates as early as March of this year.
Now investors are discounting such an early cut. Canada only added 100 jobs in December — a negative real number when you consider Canada’s still-high immigration rate. However, hourly wages were up 5.4 per cent and there was more meaningful jobs growth in service sectors, which analysts would predict to drop in a more full-blown recession. Because of the somewhat mixed signals behind this report many investors are pushing back their expectations of a BoC rate cut. According to one analyst, though, the fundamental weakness of the Canadian economy should not be understated.
“The real takeaway here is that unemployment rates in Canada have been rising consistently over the past year as labour demand has struggled to keep up with supply, given the levels of immigration that we’ve seen,” says Simon Harvey, head of FX analysis at Monex Canada. “This doesn’t necessarily symbolize a Canadian economy that is in outright contraction, as we’ve forecasted, and it doesn’t necessarily give clear-cut guidance for the Bank of Canada to start easing policy given this weak underlying level of growth.”
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Harvey notes that the shift in investor mindset around rate cuts largely comes down to the relatively high wage growth, which he sees as inconsistent with the Bank of Canada’s 2% inflation target. At the same time, global markets are pulling back somewhat on their predictions of other central bank cuts, and Canada is being brought along with that.
Nevertheless, Harvey and Monex predict cuts to come in April, with some risk that the cuts come in March. Conflicting signals, like the wage growth numbers, will be part of the road to those cuts. Moreover, Harvey believes the BoC will be hesitant to move too far away from US Federal Reserve policy. Overall he expects the BoC to take a cautious approach and avoid past pitfalls where specific data points were overreacted to. Once the cuts do begin, however, Harvey thinks that we may move towards a more neutral interest rate of around 3.5% relatively quickly.
From an asset allocation standpoint, Harvey sees Canadian bonds as somewhat more attractive than their US counterparts. In November, US bonds looked more attractive, but their price movement since then has made them too expensive at this point in his view. Canadian bonds, conversely, have been somewhat ignored by investors and may present an opportunity. He currently still expects Canada to cut sooner and deeper than the US will, which should prove advantageous for Canadian bond investors.
From a currency standpoint Harvey sees a Canadian dollar that currently is not representing the weakness of the Canadian economy. CAD has had a strong few months against the USD, in part because of rate cut expectations in the US as well as greater risk appetite among investors. Now, however, as investors pull back towards risk aversion somewhat we may see greater weakness in the Canadian dollar.
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As a broad takeaway from these jobs numbers and his wider economic outlook, Harvey believes Canadian advisors need to prepare their clients for a bumpy road. The consensus at the end of 2023 shifted somewhat towards the surefire expectations of cuts and the likelihood of growth down the road. That may not be as sure of a bet as it appeared in December. Nevertheless, the fundamental fact of real negative jobs growth implies a weakness in the economy that the BoC will have to address with interest rate cuts sooner or later.
“We may be seeing a lot of legacy effects here that are lags playing out through the data that could actually lead the Bank of Canada down the wrong path because they mask the true level of underlying weakness,” Harvey says. “It’s quite punchy to have a lot of conviction about something like that this far in advance when you are seeing these signals. But ultimately, I think that’s kind of the trick here in Q1 where we see this big adjustment in the economic cycle and we’re no longer in an environment where it’s inflation, inflation, inflation. Now it’s trying to get a better balance for the economy as a whole, and that’s going to be tricky as we adjust.”
