June or July?

Will the BoC hike on June 1, as had been widely expected as of a few weeks ago?

Or will they wait for the July meeting, given they had previously "committed", and reiterated that commitment numerous times, contingent on their inflation projections, to be on hold until the end of the second quarter... and given that economic and market uncertainty --- b/c of the situation in Europe, as well as FinReg in the U.S. --- prevails?

I tend to think that if the Bank was meeting today, given what the ECB is doing, and given what currencies are doing, and given that concerns about the possibility of a global economic double-dip may have mounted in the last couple of weeks, that it would be relatively costless for the BoC to take a wait-and-see approach for another month, whereas it would potentially look odd to hike in two weeks and then perhaps regret it.

That is, of course, if the decision were made today, in the midst of this recent turmoil. But the decision is not today. So that raises the question of what is the likelihood that some meaningful resolution of the European debt crisis is made in the next couple of weeks? In my estimation, this is a problem that is not going away; there is no short-term fix.

That said, there may be band-aids that could be applied that satisfy the market for a while, leading to a bounce-back from the currently oversold condition in stock markets and overbought condition in bond markets. In which case, that raises the question of what is the likelihood that the ECB and European politicians --- who have gotten the market so rattled in recent days and weeks --- actually come to an adequate resolution to satisfy the markets for awhile. Once again, in my estimation, the odds aren't that good; why would they change their stripes over the next week or two?

But let's leave the Euro situation off the table for now. What are the reasons the BoC might hike despite the Euro, and what are the reasons the BoC might hold off?

Hike now:
- by hiking, the Bank would not be tightening so much as starting the process of normalizing rates, and, even with a few hikes, could remain relatively accomodative for some time
- Taylor Rule estimates, based on current levels of CPI and employment, finally suggest that a rate north of 50bp is appropriate
- Q1 GDP is projected to come in up nearly 6% on an annualized basis, following Q4's rise of 1.2% (or 5% annualized)
- Canadian leading economic indicators are up 3% in the 3mths through April and 11% over the last year
- according to the Labour Force Survey, employment has climbed a whopping 148k over the last 3 mths (through April), and even the less volatile Survey of Employment Payrolls and Hours suggests employment has climbed 44k in the 3mths through Februay (pretty consistent with what the LFS said through Feb.)
- retail sales are up 9% YoY through Q1, including up 5.5% ex-autos & gas; retail sales are not just climbing strongly off trough levels, but have surged past the pre-recession peaks
- housing starts and building permits are up significantly off their 2009 lows, and basically back to 2007-type levels
- the Senior Loan Officer Survey says that banks have been easing lending conditions over the last couple of quarters (after a couple years of tightening)
- the Business Outlook Survey suggest future expectations are as positive as they've been over the last decade

Wait and see:
- as of the end of Q4, real and nominal GDP remain 2.5% and 4.4%, respectively, below the peak levels attained in 2008, so even with recent strong growth, the output gap remains substantial
- recent strong growth may be illusory and unsustainable, given that personal consumption accounts for 58% of GDP while personal income accounts for 53% of GDP, so consumption continues to be driven by debt growth;
- similarly, residential investment accounted for 6.9% of GDP at the end of Q4, presumably higher in Q1, and historically has always peaked right around that 7% level, which may portend a housing market due for some cooling
- C$, trading at 94 cents now, is below the BoC's forecasted level of 96-98 cents --- admittedly, it has only been below the Bank's forecast level for a few days, and, admittedly, a lower C$ should actually be stimulative for the economy, giving more reason for the Bank to remove accomodation, but the fact remains that a sharp fall in currency levels could be a telling indicator for the Bank
- further to last, for instance, oil prices have retreated to $70, the lowest level since last July --- which is good for the domestic demand side of the economy, but is a net negative for a net- exporter of oil, and is reflective of commodity prices more generally
- though merchandise trade exports are, through Q1, up 19% from the 2009 trough, they remain 24% below the 2008 peak --- and are sensitive to commodity prices, which have recently been heading down, as noted, and global economic activity, which is at risk
- similarly, wholesale trade is up 9% from the trough, but still down 5% from the previous peak
- though there has been recent job growth, and the number of unempoyed people, at 1.5 million, is down 6% from the worst point in 2009, there are still 42% more unemployed than at the start of the recession; and the unemployment rate, though down to 8.1% from the peak of 8.7%, remains well above the 5.8% pre-recession rate
- both core and headline CPI in Canada are below the Bank's target of 2%, and with the prevailing output gap and the other trends already mentioned, and with U.S. CPI below 1%, there's no clear reason to believe CPI would be escalating rather than be tame or even falling
- that is especially so given that though monetary reserves are up 30% YoY, M1 is up less than half that, at 13.5% YoY, M2 is up about half that, at 6.7% YoY, and M3 is up less than half that, at 2.9% YoY --- so the money multiplier and monetary velocity continue to decline
- indications of a consumer debt bubble in Canada include the facts that mortgage debt as a % of personal income has surged through the 100% level to 116% (vs. a 1990s peak of 84%) and household debt to 170% of GDP, up from 115% in 2000 (apparently Canadians learned nothing from the U.S.)
- the Fed has reiterated that it "continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period", and it is an open question as to how much the BoC can hike without the Fed hiking without currency movements adversely affecting the domestic economy (more than the Bank would be comfortable with)


Really, what it comes down to is how sure is the Bank that recent strong economic trends off recession lows are likely to be sustained?

Personally, I don't buy into the back-to-normal theory, continue to believe that:
- further leveraging (debt growth) in the Canadian economy will make the fall all the worse when it comes
- the U.S. economy has been living off of federal government stimulus for the last year and will soon fall back when (a) that stimulus wanes, and (b) the next round of credit strains (Alt-A and Prime mortgage delinquencies, defaults and related foreclosures) ramps up, and (c) the crisis at the state and municipal levels becomes impossible to ignore
- China is a bubble waiting to burst (details in earlier posts) --- and the recent stock market moves in China may be suggesting that process is underway
- even if Canada, the U.S. and China didn't have their own inherent risks, the linkages in the global economy are too significant for European retrenching not to become problematic for the global economy at large, and European retrenchment will be not just necessary in the PIIGS, but, because of the prevailing bailout mentality, will bring down the European core countries as well (though German exporters will certainly benefit from a weaker Euro, that won't help Canadian or Chinese exporters, so there will be feedback loop impacts)

So, at the end of the day, what do I forecast?

- the Bank does nothing June 1 other than change its commentary to indicate its intention to hike
- the Bank hikes 50bp in July
- the Bank hikes by 25bp once more in early September
- by autumn, things will be visibly messy again
- there will be a European recession, and a double-dip U.S. recession, a significant China slowdown, and, consequently, another Canadian recession
- though domestic demand in Canada will not lead, it will follow; Canadian domestic demand will be the tail, not the dog --- the Canadian recession will not be driven solely by external demand, but the housing and debt bubble in Canada will be pricked by the next global recession
- further BoC hikes will be off the table for a long while, not until the Fed hikes
- the Fed won't hike until perhaps 2014 (yes, Dorothy is not in Kansas anymore; like The Vapors, she, and the FOMC, are Turning Japanese)


p.s. see Canadian Economic Review