‘Rate hikes are over and done’: How Friday’s GDP surprise has shifted the views of economists and markets
Disappointing GDP figures for the second quarter indicate that the Bank of Canada is less likely to increase interest rates for the current economic period.
Canada experienced an unforeseen decline in its economy during the second quarter, with a rate of 0.2% when measured annually. The real GDP likely remained stable in July after a previous decrease of 0.2% in June, as reported by Statistics Canada.
The reading for the second quarter was significantly below what the Bank of Canada predicted for an annualized GDP growth of 1.5%, as well as lower than the 1.2% increase anticipated by analysts.
Statistics Canada stated that the decrease in economic growth during the last three months was primarily caused by a decline in housing investment, reduced accumulation of inventory, as well as slower international exports and household expenditure.
The decrease from one month to another in June aligned with predicted expectations. Statscan further adjusted its earlier report of May's GDP growth, stating a 0.2% rise instead of the initially reported 0.3% increase. The annual growth rate for the first quarter was also revised downwards from 3.1% to 2.6%.
The upcoming GDP report on Friday serves as the final substantial piece of domestic information before the Bank of Canada's forthcoming policy decision next week.
The credit markets have rapidly reevaluated the likelihood of the bank raising interest rates at the upcoming meeting. Currently, the market is expressing a high probability of approximately 91% that the Bank of Canada (BoC) will maintain the current rates. This data is derived from the implied probabilities observed in the swaps market, as reported by Refinitiv Eikon. Initially, before the release of the GDP data at 8:30 am ET, the odds of no change were hovering around 79%.
The table below shows the current estimations of the Bank of Canada's overnight rate by money markets, as of 8:40 am ET. The current overnight rate set by the Bank of Canada is 5%. Although the bank typically adjusts the rate in increments of 0.25%, the implied rates in the credit market are more volatile and constantly fluctuating. The percentages in the columns on the right represent the likelihood of future rate adjustments.
In addition to the September meeting, money markets are now indicating stronger likelihood that the bank will not increase interest rates in the coming year. By next June, money markets are predicting a nearly 50% chance that the bank will have reduced interest rates.
This is what the swaps pricing appeared like right before the release of the GDP report at 8:30 a.m. ET.
The United States issued its nonfarm payrolls report at the same time, and it also indicated a decelerating economy. The rate of unemployment surged to 3.8% in the previous month, compared to the previously recorded 3.5%. Employers incorporated 187,000 individuals into their paylists in the previous month, surpassing the numbers seen in July. However, revisions displayed that job expansion in the preceding months was not as robust as initially stated.
The latest jobs report has caused money markets to believe that the U.S. Federal Reserve has no intention of raising interest rates any further. The futures that align with the Fed's policy rate now indicate a decrease in the likelihood of U.S. central bankers implementing stricter policies this year. This probability has dropped from approximately 45% to around 38%.
The Canadian dollar has experienced a slight decrease of approximately 0.5 cents against the US dollar after the release of today's economic reports. The two-year bond yield of Canada, which is greatly influenced by the policies of the Bank of Canada, has decreased by around 4 basis points to 4.60%. Conversely, the bond yield of the United States with the same duration has remained relatively stable.
This is how economists are responding to the Canadian GDP report released on Friday:
Stephen Brown, assistant head economist for North America at Capital Economics
The unexpected decline in the second-quarter gross domestic product (GDP) clearly indicates that the Bank of Canada will maintain interest rates at their current levels in the upcoming week. Given the decrease in GDP in June and the apparent lack of growth in July, the Canadian economy might already be experiencing a slight recession.
In contrast to what we predicted, there were significant disappointments in terms of consumer spending. Despite the boost from a continuously growing population, consumer spending only increased by a small margin of 0.2% when measured on an annual basis. This indicates that interest rates are having a greater impact than we initially anticipated. We also expected a slight uptick in residential investment due to the recent increase in home sales and housing starts. However, it actually declined by a significant 8.2% when measured on an annualized basis. This decrease is likely a result of a substantial drop in investments towards renovations.
The current challenge involves determining how much of the decline in the second quarter can be attributed to temporary factors. According to the GDP by industry report from Stats Can, the wildfires in May and June had a significant impact on the agriculture and forestry sectors, and slightly affected the mining, oil, and gas sector last quarter. While this suggests that these sectors may eventually recover, there were no signs of improvement in July, as the latest estimate indicates that GDP remained unchanged. In order to avoid another decrease in quarterly GDP, it must increase by 0.1% month-on-month in both August and September. Given the ongoing disruption caused by wildfires and the weak performance in certain surveys, we remain confident in our prediction that quarterly GDP will continue to decline.
, recently discussed the impact of the current economic conditions on the housing market. He noted that the low interest rates have greatly influenced the housing market, leading to increased demand and record-high prices. Additionally, the pandemic has caused a shift in preferences, with many individuals now prioritizing larger homes and more spacious living areas. This, combined with low inventory levels, has contributed to the surge in housing prices. However, Porter also expressed concern about the sustainability of this trend, as rising prices may deter potential buyers and lead to a slowdown in the market. He emphasized the need for policymakers to monitor the situation closely and take appropriate measures to ensure a balanced and stable housing market.
The slight decrease in the second quarter GDP aligns well with the recent increase in the unemployment rate, and reinforces the fact that economic growth is slowing considerably, even when taking into account various unique factors in recent months. ... We maintain our belief that Canada will undergo a mild economic decline, and today's unexpectedly weak second quarter results only make that outcome more likely. The general weakening of the domestic economy will almost certainly lead the Bank of Canada to hold off on any further interest rate hikes at next week's meeting, following consecutive increases. With the half-point jump in the unemployment rate, the significant slowdown in GDP, and a slight decline in core inflation, it seems that interest rate hikes are no longer in the picture. Now, the Bank of Canada must simply exercise patience as they wait for inflation to align with their goals—but this may take a while, especially considering the recent rise in oil prices.
, a market research and consulting firm, recently provided some interesting insights in his blog post. He discussed various economic indicators and shared his thoughts on the current state of the market. According to Rosenberg, there are several key factors that are influencing the economy at the moment. He highlighted the importance of analyzing these factors in order to gain a deeper understanding of the overall economic landscape. Rosenberg's analysis shed light on the potential risks and opportunities that lie ahead for investors and businesses. His blog post serves as a valuable resource for those seeking to navigate the complex world of economics and make informed decisions.
It is possible that the real GDP growth in the current quarter will almost come to a halt. It is important to note that the Bank of Canada had predicted a growth of 1.5% for both the second and third quarters in their most recent forecast. Unless Tiff Macklem and his policy group believe that the Canadian economy is shrinking, the GDP data clearly indicate that there is a decrease in inflationary output and as a result, the central bank will likely take a backseat. The Canadian economy, despite the increase in immigration, is clearly performing worse than the U.S. This will have a negative impact on the Canadian dollar, which is commonly referred to as the "loonie," and it will rightfully earn this nickname (as in — a bird that cannot fly).
James Orlando, head and senior economist at TD Economics
Well, it seems like the idea of an economy getting too hot was a bit off. Even though it was widely predicted that Canada's economy would slow down in the second quarter of 2023, today's report shows that it actually fell well below what was expected. ... Although the government's transfers in July might give a temporary boost in the third quarter, we think that Canada is now experiencing a period of economic growth that is below the usual rate. This is likely to continue for the rest of the year, as the effects of high interest rates take their toll on the economy and prevent a further increase in demand.
During the months of June and July, the Bank of Canada made the decision to increase interest rates primarily due to the strong momentum of consumer activity in the first quarter of 2023. However, with the release of today's weak report and a decrease in employment growth to an average of 12k per month (compared to 80k in the first quarter), consumer demand is expected to continue hindering economic growth. This decrease in momentum aligns with the desired outcome of the Bank of Canada, as it indicates that inflation will likely continue to move towards the target of 2%. Based on this analysis, we believe that the Bank of Canada will refrain from making any further changes to interest rates for the remainder of this year.
In the blogging domain, two economists from National Bank Financial, namely Matthieu Arseneau and Alexandra Ducharme, have made noteworthy contributions.
The data released this morning is much worse than the previous monthly GDP figures and falls way below what economists had predicted. To add to the disappointment, the growth in the first quarter has been revised down by 0.5% (from 3.1% to 2.6%). This means that the economy is not as overheated as the Bank of Canada had believed in July. Instead of the projected growth of 1.5% in the second quarter, the actual growth was -0.2%. Under normal circumstances, a stagnant quarter like the second quarter wouldn't be too concerning. However, the current situation is anything but normal due to the rapid growth in population. When taking this into consideration, the real GDP per person actually dropped significantly in the second quarter, with an annualized rate of 3.1%. This marks the fourth consecutive quarterly decline, which coincides with the central bank's decision to tighten monetary policy. Compared to the second quarter of 2022, GDP per person has decreased by 2.0% over the four quarters leading up to the second quarter of 2023. To put this into historical context, a similar decline in GDP per person has happened four times in the last four recessions. In each of those instances, the central bank had already begun easing monetary policy when GDP per person was just slightly lower than the previous year's level. This is in contrast to the current stance of the Bank of Canada, which is adopting a more hawkish approach.
Recent evidence suggests that the economy has been growing well below its potential. The unemployment rate has experienced a significant increase of five-tenths of a percent within a span of four months. Based on the current trends in profits and investment over the past four quarters, it is highly likely that companies will have little desire to hire new employees and may even have to resort to job cuts. The rise in employee compensation, which has reached an annualized rate of 8% since the start of the year, does not align with the decline in corporate profits by 26%. This disconnect between compensation and profits could lead to difficult decisions for businesses. In August, concerns about weak domestic demand grew considerably, as revealed by the latest CFIB survey. This is not a promising sign for a stronger economy in the third quarter. Additionally, the preliminary estimate for the month of July indicates a stagnant economy, which is concerning considering that many households received a food rebate from the government during that time. As monetary policy is the most restrictive among the G7 countries when considering real terms, we believe that this economic weakness is not temporary. Consequently, we predict continued sluggishness in the economy for the next 12 months.
, recently published an article on the current state of the housing market. In her piece, she examines the factors contributing to the increase in home prices and the impact it has on potential buyers. In her blog post, Katherine Judge, an economist at CIBC Capital Markets, discusses the present condition of the housing sector. Within her article, she explores the elements that contribute to the rise in housing costs and the consequences it poses for prospective purchasers.
Forest fires may have slightly affected the data, but the Canadian economy is not experiencing significant growth, which raises doubts about claims that it can handle higher interest rates. After a brief period of growth, the GDP decreased in the second quarter, making the previous rate hike seem excessive and making it unlikely that there will be another hike next week. The decrease in housing investment, along with slower inventory investment and sluggish export growth, contributed to this decline. Additionally, consumption growth slowed down to 0.2% annually, and the previous quarter's spending spree now appears to have been a one-time event, with minimal growth in three out of the last four quarters. It seems that the consumer resilience that the Bank of Canada had mentioned as a reason for raising rates further is not as strong as they thought.
The decrease in investment in housing was somewhat surprising considering the increase in the number of homes sold. However, this decline can be attributed to a decrease in new construction and renovation projects. While this is not great news for inflation in the housing market, the overall slowing of activities and labor markets should have a disinflationary effect. Another negative factor for the quarter was the decrease in inventory investment due to an excess of inventories compared to the rate of sales, which is a result of declining demand for goods. This decline is not only limited to domestic consumer demand, as there was also a 2.1% annualized decrease in goods exports. Some of this can be attributed to disruptions in energy production caused by fires in Alberta, but the global growth prospects are not strong enough to suggest that trade will significantly improve from this point onward.
The decline in spending will probably hinder the Bank of Canada from raising interest rates any further. The beginning of the third quarter also appears to be weak, which will add to the increasing amount of unemployed workers, an important factor in reducing inflation caused by domestic factors.
Derek Holt, the deputy CEO and leader of Financial Markets Economics at Scotiabank
The general story is that the GDP information suggests that Canada's economy has finally weakened due to interest rate increases. However, I believe that this headline commentary is superficial and lacks depth. When we delve into the actual details and consider different factors such as the widespread effect of wildfires, strikes, and possibly even weather, we can see that the economy is actually much stronger.
The Bank of Canada has decided to maintain a cautious stance on Wednesday due to unfavorable GDP data. Growth turned out to be significantly lower than initially predicted. Furthermore, the bank is expected to carefully assess the situation by conducting a thorough forecast examination during the October MPR and analyzing incoming data. They aim to gain a comprehensive understanding of the underlying factors behind the weakness in order to form an updated perspective on the extent of its transitory nature. Personally, I believe a large portion of the weakness is temporary, but I am curious to hear the opinions of the bank's economists and policymakers. At present, the Bank of Canada must keep the possibility of future tightening open in their statement due to three key reasons.
• First and foremost, I believe that these numbers indicate a temporary situation, and it is highly likely that we will observe strong signs of recovery by the end of the year as multiple unexpected events fade away.
• The second point is that the BoC must effectively handle market situations and prevent hasty decisions to reduce interest rates. It is commonly emphasized that past experiences strongly advise against prematurely assuming that inflation has been successfully controlled, especially in today's era of significant structural transformations.
• Firstly, it is important to note that the Bank of Canada (BoC) has clearly stated their emphasis on considering various factors that impact core inflation, such as inflation expectations, wages, productivity, and the pricing behavior of corporations. Governor Macklem has further expressed the need for a decrease in demand growth, and the current figures are a move towards that objective. However, it is crucial to ensure that any temporary decline does not lead to a mere rebound effect.
Nathan Janzen, deputy principal economist, RBC Economics
The information regarding the country's GDP should strengthen the belief that the Bank of Canada (BoC) will not raise interest rates next week and instead maintain their current stance. The BoC will not give too much importance to just one set of data, and the rate of inflation is still persistently high, which is not in line with their desired target. However, there is growing evidence that the previous interest rate hikes are starting to have a more significant impact on slowing down GDP growth and the job market. This suggests that inflationary pressures will gradually decrease. The policymakers will want to keep the option of raising interest rates again in the future if necessary. However, if the unemployment rate continues to rise, as we predict, there will be no need to consider raising rates again.
Philip Petursson, the top investment strategist at IG Wealth Management
The report was not very favorable and had many disappointing aspects. The spending by households was much weaker than the previous quarter, and the investment in residential properties continued to have a negative impact. The main reason behind the weakness in the report was the consumer. This shows how the higher interest rates have affected Canadian consumers. Moreover, two out of the last three quarters have shown a decline in GDP growth on an annual basis. Considering this, we believe that the Bank of Canada will take a break next week. In fact, if this report is an accurate reflection of the current trend, which we believe it is, the Bank of Canada has completed its tightening cycle.
Bryan Yu, the head economist at Central 1 (a credit union)
This represents the final important data release before the Bank of Canada makes its decision on interest rates in September. It is likely that this disappointing outcome will have a significant impact on the Bank's decision to maintain the current rates. This is due to additional evidence of a decrease in core inflation, a weakening job market, and less consumer demand. We anticipate that the Bank will keep rates unchanged until the first quarter of 2024, at which point it will likely begin implementing rate cuts.
