Douglas Porter

November 5, 2021

This week can be summed up as one in which the Fed’s QE was hived, equities thrived, bond yields dived, even as US growth revived, and wage inflation arrived. Turning the page on the most challenging portion of the calendar, stocks knocked down a series of gains, lifting the MSCI World index to record highs, and up a cool 30% from year-ago levels. The only semi-serious challenge to that formidable upward march has been a 5% mini-correction in September. The S&P 500 popped more than 2% on the week, rising more than 100 points to above the 4,700 level. The TSX largely kept pace, after a rare stumble last week, reaching record highs even as oil prices wobbled around the $80 level.

This week’s highly anticipated Federal Open Market Committee (FOMC) meeting turned out to not be a major market mover, as the Fed almost precisely stuck to the script. Announcing a mid-month start to tapering, of $15 billion per month from the pre-existing $120 billion bond purchases, met expectations. So, too, did its overall view of the economy and its ongoing description of inflation as transitory. Perhaps most importantly, the Fed did not meet the most hawkish fears, and did not jump on the rate-hike-warning bandwagon of other central banks. In fact, the biggest market-moving bank of the week was the Bank of England, which stunned by standing still on Thursday. As a measure of how this caught markets unawares, the 2-year Gilt yield plunged 21 bps that day, just shy of a similar plunge the day after the Brexit vote in 2016.

The BoE’s decision to stay on hold seemed to break the fever of rate-hike expectations globally. For example, Canadian two-year yields gave back more than half of last week’s 22 bp leap, and the pullback extended right out the GoC curve. Notably, though, 10-year Canadian yields remain firmly planted above like-dated Treasuries, even with an 12 bp drop this week. Aside from a brief spell during the spring of 2020, Canada-US spreads have not been positive since 2013. The divergence mostly reflects the ongoing expectation of a much more aggressive rate-hike plan by the BoC. Even with some retreat, the market is still priced for at least four rate hikes by the Bank in 2022, versus just under two moves by the Fed.

The upswing in relative long-term yields is a bit curious, given that US inflation forces are arguably more intense than their Canadian counterparts at this point. First, there is the reality on the ground that headline inflation is currently running hotter in the US (5.4% vs. 4.4% on CPI), and next week’s important reading is expected to show another marked bump-up to a 6% clip. (Aside: US headline inflation last visited 6% in late 1990, when oil prices spiked in the first Gulf War.) The strength in the Canadian dollar in the past year is one factor holding inflation back, somewhat, as the loonie is up nearly 5% from a year ago, even with a sag this week.

But it is on the labour market front where US wage pressures seem to be much more intense than in Canada. The latest jobs report was above expectations stateside, with a solid 531,000 payroll gain (replete with big upward revisions to earlier months), and the jobless rate dipped two ticks to 4.6%. This pulled the number of those officially counted as unemployed down to 7.4 million, versus the latest report of 10.4 million job openings. The ratio of openings to unemployed has thus risen to a towering 1.41 to 1, a massive imbalance. For perspective, the similar ratio in Canada, while historically high, is in a different postal code at around 0.5 to 1.

This gap is in spite of the fact that Canada’s unemployment rate has matched the US move almost step for step. The former also dipped two ticks in October to 6.7% (amid a so-so jobs gain of 31,200), and is similarly up 1 percentage point versus pre-pandemic levels. Yet, the key difference between the two job markets is that Canadians have apparently been much more willing and able to rejoin the labour force. Its participation rate edged down last month but is only slightly below its pre-pandemic level at 65.3%. In contrast, the US part rate held steady at 61.6%, down from 63.3% in early 2020, and well south of Canada’s rate. Drilling into the prime working age population, Canada’s part rate for those 15-64 has risen during the pandemic to 79.5%, while the US rate for those 16-64 has dipped to 73.4%—a hefty 6 ppts below Canada. This wide gap reinforces the impression that the US worker shortage is much more intense.

In turn, most US wage measures are flashing much more serious stress. Average hourly earnings rose a sturdy 0.4% in October, lifting them 4.9% above a year ago. And it’s not like wages were a shrinking violet a year ago, with the two-year trend now rising to 4.7%, the fastest pace since the early 1980s. This wage metric is imperfect, since it doesn’t adjust for sectoral changes. However, other broad measures of wages, that better account for potential distortions, are sending a similar loud warning signal. To wit, the employment cost index—which may be the single best wage measure of them all—revealed late last week that wages & salaries rose 4.2% y/y in Q3, a three-decade high. In a similar light, unit labour costs have jumped at a 4.1% annualized pace in the past two years, a four-decade high. Fed Chair Powell suggested that wage gains are not yet “troubling”, because they are not yet outpacing inflation and productivity. Given the increasingly severe worker shortages, trouble is brewing.

Canadian wage trends remain positively tame by comparison. The average hourly wage measure reported a mild 2.0% y/y rise in October, although the two-year clip is a meatier 3.7%. However, when adjusted for sectoral changes, StatCan reports that such wages have grown at a notably mild 2.6% annualized pace over the past two years. And, forward-looking indicators are also not pointing to a burst in wage pressures. The latest CFIB survey found that its members expect to boost wages a moderate 2.5% over the next year, well shy of anticipated price increases of nearly 4%. Even this week’s news that Ontario will lift its minimum wage to $15 doesn’t really change the picture, as this represents a non-game-changing 4.5% rise from current levels.

Overall, it appears that the US has a much more threatening inflation issue on its hands than does Canada. This raises serious questions on why the Fed seems so much more patient than the BoC—the 2-year Treasury yield of about 0.40% remains more than 50 bps below the 2-year GoC, even as the US job market is screaming rising wage pressures. And market pricing is simply reflecting the messaging from the respective central banks, not to mention the diverging pace of tapering (the BoC is done with QE just as the Fed is only starting to wind it down). Our view is that it is the Fed that is out of step with the inflation news on the ground, and not the Bank of Canada. Could the fact that the Fed Chair is still awaiting his fate on re-nomination be playing a small role in this foot-dragging?

Housing prices could still carry some serious sting in the tail for inflation in the year ahead. Every country handles housing a little differently in its CPI calculations. But one commonality is that it takes time for a big run in housing to be fully reflected in inflation. And, make no mistake: those home prices are still heading due north. The early results from Canada’s big cities point to a re-heating of the market in October. The bottom line is that average prices still look to be rising at a torrid 20% clip, with medium-sized cities leading the way. The picture is almost identical in the US, as the Case-Shiller Index rose a crackling 19.7% y/y in August. Yet, in the CPI, the heavyweight owners’ equivalent rent component has risen a tame 2.9% y/y. Given that it takes roughly 18 months for a home price surge to fully be reflected in inflation, look out above on the shelter component of core inflation.

Doug Porter is chief economist and managing director, BMO Financial Group. His weekly Talking Points memo is published by Policy Online with permission from BMO.