Inflation rate eases, cementing case for Bank of Canada rate cut

The Consumer Price Index rose at an annual rate of 2.5 per cent in July, down from 2.7 per cent in June and matching analyst estimates, Statistics Canada said Tuesday in a report. It was the lowest annual inflation rate since March, 2021.

Inflationary pressures are easing in many areas, with prices for passenger vehicles, travel tours and electricity falling from a year earlier. The housing sector – a persistent area of financial pressure – is also showing signs of slight moderation. (…)

At the July rate announcement, the Bank of Canada’s six-person governing council said that it was putting more emphasis on downside risks to the economy and the possibility that inflation could undershoot the 2-per-cent target on the way down. This marked an important shift in how the central bank is approaching its monetary-policy deliberations. (…)

Some measures of core inflation – which strip out volatile movements in the CPI – cooled last month. On a three-month annualized basis, the central bank’s preferred measures of core inflation rose by an average of 2.7 per cent in July, down from 2.9 per cent in June.

Consumer prices rose 0.4 per cent in July from June, in figures that were unadjusted for seasonality. Gasoline was a key contributor to the increase: Those costs rose 2.4 per cent during the month.

Grocery prices rose 2.1 per cent in July on an annual basis, matching the increase in June. Groceries have experienced a pullback from peak increases of roughly 11 per cent in late 2022 and early 2023.

Conversely, there are several products that are experiencing price cuts. For example, the price of passenger vehicles fell 1.4 per cent in July, year-over-year. This is being driven by the used-car segment, which has seen prices tumble by 5.7 per cent over the past year as inventory levels improve.

Shelter costs rose by 5.7 per cent on an annual basis, down from a 6.2-per-cent pace in June, and the first reading below 6 per cent since December. With interest rates in decline, this is easing some pressure on mortgage interest costs. While those costs have soared by 21 per cent year-over-year, that is down from peak increases of roughly 30 per cent in 2023. (…)

Dethroning King Dollar

John Authers:

The dollar’s weakening is growing impossible to ignore, and it stains the otherwise remarkable recovery on Wall Street after one of the biggest market selloffs since the pandemic. The currency slumped in Tuesday trading to its lowest point this year. Its recent troubles precede the unwinding of the yen carry trade (which has resumed this week), and its pain is the gain for developed market peers. The euro and the pound surged to 2024 highs. The dollar fell against the Swedish krona despite the Riksbank delivering its second rate cut this year:

This is more of a US problem than a resurgence by other currencies. Bannockburn Global Forex’s Marc Chandler dismisses the idea that European markets are driving the euro’s exceptional performance. Rather, he assesses that what’s moving the foreign exchange markets are events in the United States, especially increasingly imminent rate cuts:

It’s not about what’s going on in Europe. I don’t think people are getting more optimistic about China, but people are getting more pessimistic about the top-dog country being among the best-performing economies. I still think we live in a world where what happens in the US often drives the capital markets.

The fact that the US is late to the policy-easing party is exerting pressure on its currency, despite helping the dollar to rally earlier this year. This chart shows how optimism for rate cuts in the US is growing compared to elsewhere:

The dollar’s troubles coincide with a significant decline in US Treasury yields, which have picked up only slightly since the big stock market selloff at the start of the month. Standard Chartered Bank’s Steven Englander views this as a case of “risk on” dollar weakness as markets recover from the rout:

You’re seeing asset equity market rebound — typically the dollar-negative signal — as US yields come down. But in contrast, in the last week of July and the beginning of August, US yields aren’t coming down because of safe haven issues. They’re coming down because the market is comfortable that inflation is coming down. So, this combination of the market reading risk and, at the same time, the rates are coming off while global equities are picking up, is historically a dollar negative.

Investors see a September rate cut as a certainty even with several important economic data prints still to come. Whether the Fed delivers its usual 25 basis-point cut or aims higher will depend on that data. Investors leaning toward 50 basis points expect a significant worsening in the job market that leaves the Fed with no other option. Such an outsized move would exacerbate the dollar’s precarious position. For now, markets are broadly convinced that a quarter-basis point reduction to the fed funds rate is in order. Englander argues that while this is enough to maintain risk appetite and keep yields flowing, it remains detrimental to the dollar. (…)

The dollar is still super-strong, Juckes adds, just not as strong as it was. Pointing to the Bank of International Settlements’ broad real effective exchange rate for the dollar, which takes into account different inflation rates, he shows that the dollar is still above its 1998 peak during the Asia crisis and Long-Term Capital Management meltdown. It’s also about 40% higher in real terms than at the Global Financial Crisis low. That’s not “weak” in his book:

Juckes says, however, that there may have been so much foreign money invested in dollar assets (led by Magnificent Seven stocks and US Treasury bonds) for so long that the currency could slip a long way once it starts to fall. This is not necessarily alarming. He points out that the massive Reagan/Volcker dollar rally of the 1980s “unwound completely without a recession,” while the currency was back at 1995 levels by 2004 without much weakness — even though Alan Greenspan cut rates sharply. The other possibility is that “there are a lot of people who actually believe what is priced into the rates curve, i.e., a serious slowdown, big easing cycle etc.” (…)

The New Consensus on Trade Is Wrong and Dangerous The populist left and populist right are now closely aligned in their support for protectionism. Good luck with that.

One of the most enduring fallacies in politicians’ talk about economics is the idea that trade deficits are a problem in their own right, regardless of why and how they arise. If you’re importing more than you’re exporting, goes the argument, you’re a loser – and the key to success in economic policy is to attack this imbalance. In the US, the populist left and the populist right are now closely aligned in their support for this nonsense.

It’s dangerous as well as tiresome. The measures meant to cut trade deficits invariably fail, but not harmlessly: They also cause collateral damage. Republicans and Democrats have come to support an expansive range of protectionist policies. As countless times before, these self-defeating initiatives will end up proving the point.

Note first that balance-of-payments deficits necessarily mirror external financial surpluses. The two are equal as a matter of accounting identity – different ways of measuring the same thing. The capital-account surplus standing alongside a balance-of-payments deficit means that the economy is using foreign capital to invest more than it’s saving. This might be a good thing, depending on what produced these matched imbalances. High investment financed by foreign saving means faster growth. But if policies aimed at raising exports and lowering imports result in less investment, shrinking the trade deficit is a bad idea.

Tariffs on imported EVs, say, combined with subsidies for EVs made in the US will certainly reduce imports of EVs and create new jobs in EV factories. But what happens if the investment-saving gap doesn’t change? Then the trade deficit won’t change. The cut in EV imports will be matched either by a rise in other imports or by a cut in total exports, which is to say that jobs elsewhere will be lost. Consumers are now obliged to buy expensive EVs rather than cheap EVs, which represents an economic loss. Jobs have been moved around – and that, admittedly, might be a legitimate policy goal – but they haven’t been created on net. And the trade deficit hasn’t budged.

By the way, if the subsidies aren’t paid for with higher taxes or cuts in other public spending, the government must borrow more, which reduces national saving, which requires either lower investment or a bigger capital-account surplus. And if it’s the latter, this ingenious assault on the trade deficit will end up making it bigger.

Because of this underlying logic, Trump-style tariffs as a solution to America’s supposed trade-deficit problem garner next to no academic support. But a more sophisticated line of analysis recognizes the importance of the saving-investment balance for trade and employment, and suggests another policy approach. In effect, it agrees with ordinary old-fashioned protectionism in blaming foreigners for US “deindustrialization,” but shifts the focus to capital flows.

The decade leading up to the crash of 2008 is the center of this version of the story. The trade deficit surged in those years, alongside a dramatic increase in capital inflows following the Asian financial crisis of the late 1990s. (Asian central banks expanded their foreign-currency reserves by buying huge amounts of US Treasury debt.) The inflows drove up the dollar and made imports cheap and US exports expensive; the trade deficit expanded accordingly.

This view suggests two superficially plausible responses. First, do what you can to keep the dollar cheap. Second, deter excessive capital inflows by taxing them. Robert Lighthizer, Trump’s former US Trade Representative and presumably a key adviser if Trump wins a second term, appears to favor both. Trump has also mused over the need to give the president a say in Fed policy, perhaps with the aim of using low interest rates to keep the dollar cheap.

A new paper by Maurice Obstfeld, formerly chief economist of the International Monetary Fund, explains the defects of this subtler way of blaming foreigners for US economic problems.

The saving-glut story, according to Obstfeld, works pretty well for the first part of the decade. The supply of capital to the US did surge, the dollar did appreciate and the trade deficit grew rapidly as Asian investors and central banks forced their lending on America – all as you would expect. The problem is that starting in 2002, the dollar began to depreciate. This suggests a switch in the balance of supply and demand for capital. Before 2002, the dominant force was excess foreign supply (causing the dollar to rise); from 2002 it was excess US demand (causing the dollar to fall despite the continuing capital inflow). The trade deficit kept widening despite the dollar’s depreciation because imports grew even faster than exports under the pressure of too much domestic demand.

On this telling, the culprit after 2002 was excessively easy financial conditions in the US – due partly to the Federal Reserve’s interest-rate cuts and, more important, a surge in domestic borrowing and asset prices driven by financial deregulation and innovation. “For the most part,” Obstfeld says, “foreign capital did not push in during 2002-06, it was pulled in.” So much for the first remedy – keeping the dollar cheap. This doesn’t necessarily shrink the deficit. Also, if you keep it cheap by commanding the Fed to suppress interest rates, the deficit might very well expand, and you’ll get soaring inflation as a bonus.

What about the other remedy – taxing capital inflows? This would indeed reduce the capital-account surplus and hence the trade deficit, but only by raising the cost of borrowing and discouraging investment. If the Fed resisted this growth-depressing effect by keeping rates low, the result would again be higher inflation. As before, misdiagnosing the problem leads to a remedy that makes things worse.

Trade deficits are dangerous mainly because of the stupid policy responses they tend to provoke. However, when for some reason they do in fact need to be reduced, remember that there’s a straightforward and effective way to do it: Reduce the investment-saving gap with lower public borrowing. In the end, trade deficits are caused and cured with macroeconomic policy, and the best trade policy is fiscal control. Strange that no US politician is talking about that.

Jobs, Consumer Watch

Warning Signs Flash in a Labor Survey as Fed Officials Watch for Weakness The New York Fed’s labor market survey showed cracks just as Jerome H. Powell, the Fed chair, prepares for a closely watched Friday speech.

Americans are increasingly worried about losing their jobs, a new survey from the Federal Reserve Bank of New York released on Monday showed, a worrying sign at a moment when economists and central bankers are warily monitoring for cracks in the job market.

The New York Fed’s July survey of labor market expectations showed that the expected likelihood of becoming unemployed rose to 4.4 percent on average, up from 3.9 percent a year earlier and the highest in data going back to 2014.

In fact, the new data showed signs of the labor market cracking across a range of metrics. People reported leaving or losing jobs, marked down their salary expectations and increasingly thought that they would need to work past traditional retirement ages. The share of workers who reported searching for a job in the past four weeks jumped to 28.4 percent — the highest level since the data started — up from 19.4 percent in July 2023.

The survey, which quizzes a nationally representative sample of people on their recent economic experience, suggested that meaningful fissures may be forming in the labor market. While it is just one report, it comes at a tense moment, as economists and central bankers watch nervously for signs that the job market is taking a turn for the worse. (…)

More from the report:

Experiences

• Among those who were employed four months ago, 88% were still employed, a series low since the start of the survey and down from 91.4% in July 2023. The rate of transitioning to a different employer increased to 7.1%—the highest reading since the start of the survey—from 5.3% in July 2023. The increase compared to a year ago was primarily driven by women.
• The proportion of individuals who reported searching for a job in the past four weeks increased to 28.4%—the highest level since March 2014—from 19.4% in July 2023. The increase was most pronounced among respondents older than age 45, those without a college degree, and those with an annual household income less than $60,000. (…)
• Satisfaction with wage compensation, nonwage benefits, and promotion opportunities at respondents’ current jobs all deteriorated relative to a year ago. Satisfaction with wage compensation at the current job fell to 56.7% from 59.9% in July 2023. Satisfaction with nonwage benefits fell to 56.3% from 64.9%. And satisfaction with promotion opportunities dropped to 44.2% from 53.5%. (…)

Expectations

• The expected likelihood of moving to a new employer increased to 11.6% from 10.6% in July 2023, while the average expected likelihood of becoming unemployed rose to 4.4% from 3.9% in July 2023. The current reading is the highest since the series started in July 2014.
• The average expected likelihood of receiving at least one job offer in the next four months increased to 22.2% from 18.7% in July 2023. The average expected likelihood of receiving multiple offers in the next four months rose to 25.4% from 20.6% in July 2023. (…)
• The average expected likelihood of working beyond age 62 increased to 48.3% from 47.7% in July 2023, and versus a series low of 45.8% in March 2024. The average expected likelihood of working beyond age 67 increased to 34.2% from 32% in July 2023, partially reversing the steady declining trend observed in the series since the onset of the pandemic.

Yesterday, I posted these 2 charts suggesting a stabilizing labor market as characterized by Jay Powell last month:

• Indeed job postings suggest rising labor demand since June (Indeed data through August 8).

Goldman Sachs:

The July employment report was soft, as payroll growth slowed sharply and the unemployment rate rose to 4.3%. More recent data have somewhat alleviated labor market concerns, however, as the employment component of the nonmanufacturing ISM index returned to expansion territory for the first time since November 2023 and initial jobless claims have edged back down.

Furthermore, our estimate of underlying job gains (146k/month) remains near its breakeven pace and our jobs-workers gap continues to signal that there are still 1.1mn more open jobs than unemployed workers seeking to fill them. We therefore forecast that firm labor demand and continued labor force expansion on the back of still-elevated (albeit slowing) immigration will lead job growth to average around 145k/month for the remainder of 2024, and we expect that the unemployment rate will edge down to 4.2% by end-2024.

From The Transcript:

• “We did not see a step down and our outlook for the back half of the year is really for more of a continuation of what we’ve seen. Even in the first couple weeks of August here, things have been remarkably consistent. So I know everyone is looking for some piece of information that maybe indicates further weakness with our members and our customers, we’re not seeing it…So far, we aren’t experiencing a weaker consumer overall” — Walmart ($WMT ) CFO John D. Rainey 
• “Well, in our consumer base of 60 million customers spending every week, what you’re seeing is they’re spending at a rate of growth of this year over last year, for July and August so far, about 3%. That is half the rate it was last year at this time. And so the consumer has slowed down. They have money in their accounts, but they’re depleting a little bit. They’re employed, they’re earning money, but if you look at- they’ve really slowed down. So the Fed is in a position they have to be careful that they don’t slow down too much.” — Bank of America ($BAC ) CEO Brian Moynihan

But 3% YoY growth in nominal retail sales (black) is no “real slowdown” in real terms when inflation goes from +2.0% to –0.6%  or when CPI-Durables goes from 0% to –4.0%.

China Unleashes Rapid Drop in New-Home Prices With Relaxed Curbs At least 10 cities relaxed, removed new home price guidance

In Beijing, a sudden 18% price cut in May at a mid-sized residential project on the city’s outskirts has forced adjacent new developments to follow suit, according to people familiar, who requested not to be named because the matter is private. Near the southern border, the Shenzhen government approved a 29% cut in unit prices for a complex compared with a year ago, according to other people familiar.

After intervening for years, at least 10 city governments have relaxed or scrapped new-home price guidances to let market demand play a bigger role, according to China Index Holdings Ltd. and public statements.

While it’s mostly smaller cities that have announced the moves, the examples in Beijing and Shenzhen show that even bureaucrats in megacities are starting to relax prices on a case-by-case basis.

The move is expected to drive more developers to cut prices as they benchmark against the second-hand market that’s seen a much steeper decline. That will help remove longstanding market distortions created by government meddling, even if it keeps some buyers on the sidelines as they wait to see how far new-home values will fall. (…)

For years, China’s housing authority tinkered with the price range at which new homes were sold through a “pre-sales permit.” The approach kept new-home prices in the biggest cities in check since late 2016 following a property frenzy. But when second-hand homes went into freefall, the arrangement kept new-home values abnormally resilient. That in turn made it even harder for companies to sell their inventory. (…)

New-home values have declined about 7.2% from June 2021, about half of the 13.6% drop seen in existing-home prices.

Prices of second-hand homes in Shenzhen, once China’s least affordable city, have plunged 37% from a peak in May 2021, according to Centaline Group. They’ve tanked by about 27% in Beijing, Shanghai and Guangzhou from their respective peaks.

The bargains pushed Shenzhen’s existing-home sales in July to the highest by monthly volume in more than four years, according to the city’s biggest real estate agency Leyoujia. The same month, its new-home sales shrank 11% by units from a month earlier. (…)

Many of the cash-strapped developers, who have been in default for more than a year, are counting on sales to reassure debt holders and fight off liquidation.

At least 20 Chinese developers have faced wind-up petitions, according to data compiled by Bloomberg. Dexin China Holdings Co. in June became the latest builder to receive a liquidation order from a Hong Kong court, following China Evergrande Group and Jiayuan International Group Ltd.

In addition, about 80 out of the top 200 real estate companies operating in China have been mired in default, according to data compiled by Bloomberg. More could follow as new-home sales haven’t fully recovered, China Real Estate Information Corp warned in note on Aug. 8. (…)

This will be unsettling for Chinese for a while but improved affordability and the gradual elimination of the inventory overhang will help stabilize prices and restore sentiment. The PBOC survey of urban depositors shows that the share of households expecting falling house prices reached a new high of 24% in Q2 from 10% on average pre-pandemic.

• China Weighs Letting Local Governments Issue Bonds to Buy Homes

The latest proposal would allow local governments to fund their home purchases by issuing so-called special bonds, the proceeds of which are currently restricted to uses including infrastructure and environmental projects, the people said, asking not to be named discussing private information. Local governments have already used more than half the 3.9 trillion yuan ($546 billion) quota for special bond issuance this year; it’s unclear what portion of the remainder might be directed toward home purchases if the plan is approved. (…)

Only about 8% of the 580 billion yuan available from existing rescue funds has been tapped so far, including a high-profile initiative to backstop home purchases with central bank funding, according to Bloomberg Intelligence.

That’s partly because the expected return from turning unsold homes into affordable housing has stayed below the cost of funding for many local-government borrowers. Rental yields in China’s tier-1 cities averaged just 1.4% in 2023, compared with the central bank’s relending rate of 1.75%, Macquarie Group Ltd.’s economists wrote in May, citing data from Centaline Property Agency. The city of Beijing has recently issued one-year special bonds at 1.65%.

China had 382 million square meters of unsold homes as of July, equivalent to about the size of Detroit, according to official data. The crisis has dragged down everything from the job market to consumption and household wealth over the past two years. President Xi Jinping unveiled sweeping goals last month to bolster the finances of China’s indebted local governments and give them more autonomy in regulating local property markets, though public details of the initiatives have so far been limited.

While state buying of housing inventory is widely seen as a key step toward easing the housing glut and boosting developers’ finances, the central bank’s initial funding is just a fraction of the 1 trillion yuan to 5 trillion yuan that some analysts estimate is needed to address the supply-demand mismatch. (…)

Separately, the Ministry of Natural Resources said in June that it is working with the National Development and Reform Commission to roll out a policy that would allow local governments to buy land using special bonds. (…)

China plans ‘bigger, stronger’ social security fund to aid ageing society

China will beef up its 2.88 trillion yuan ($406 billion) social security fund, making it “bigger and stronger” to help support its rapidly ageing population as the number of new births and younger workforce to support its seniors shrinks. (…)

Ding said the fund will improve and expand the scale of pension fund investments, “actively disclose important financial information to the public” and carry out investments in an “open and transparent manner.”

The disclosures aim to stabilise people’s expectations of old age care, he said. (…)

First concrete steps to improve China’s safety net.

Meanwhile, there are other steps showing China’s broad policy relaxations to boost growth. This is from Almost Daily Grant’s:

A new day of Sino-American collaboration is at hand, as the U.S.-China Financial Working Group hammered out cooperation agreements late last week pertaining to systemically important banks, cross-border payments and monetary policy, among other topics. 

Conversations were “professional, pragmatic, candid and constructive” according to a summary from the People’s Bank of China, allowing “the financial management departments of both sides to maintain timely and smooth communication channels and reduce uncertainty [during] financial stress events.”

Renewed efforts by the Middle Kingdom to attract foreign capital colors that regulatory alliance, as state media revealed Friday that Beijing will permit unfettered overseas investment in its lynchpin manufacturing realm, while likewise relaxing strictures across other politically sensitive sectors.  That bulletin comes two days after a Ministry of Commerce convened-powwow with representatives from 20 foreign firms including Siemens, SAP, Lego and Medtronic to streamline planned projects within the world’s second-largest economy, with the South China Morning Post reporting that the government invited those companies to get started “at their earliest convenience.”

Informing that conciliatory stance: inbound foreign direct investment summed to RMB 539.47 billion ($75.2 billion) over the first six months of the year, state compiled data show, down 29.6% from the same period a year ago.  Similarly, China’s direct investment liabilities in its balance of payments – a measure of foreign direct investment which includes retained earnings – tumbled by nearly $15 billion during the second quarter according to the State Administration of Foreign Exchange (SAFE) following a $5 billion decline from January to March, putting that metric on pace for its first ever annual decline in a data series stretching to 1990.

At the same time, outbound investment reached a record $71 billion over the three months through June, representing a near 80% jump from the $39 billion logged in the second quarter of 2023. In response to “surging appetite” for overseas securities, Reuters relays that banks and asset managers are “scrambling” to bypass state-mandated quotas, reflecting the “latest sign of investors’ lack of confidence in local assets.”

Indeed, international investors have pulled a net $12 billion from mainland equities since the start of June according to data from the Hong Kong stock exchange, leaving that metric in a net outflow since the start of 2024.  That has never happened over a full year period since China introduced the Stock Connect trading link, which allows foreign investors to access the market, in 2014.

By way of response, local authorities likewise turn to a well-worn playbook. As the Financial Times reports today, daily data showing foreign investment flows on the Stock Connect are no longer available for viewing, with that information now restricted to quarterly updates.

To little surprise, that decision did not garner universal applause. “While the data provided by global exchanges often vary, the lower transparency will not help attract foreign investment, especially in an emerging market,” Gary Ng, senior economist at Natixis, told the pink paper. “Investors may wonder why it is no longer offered and find it more challenging to justify entry into China.”

Harris proposes raising the corporate tax rate to 28%, rolling back a Trump law

(…) If enacted, the policy would raise hundreds of billions of dollars, as the nonpartisan Congressional Budget Office has projected that 1 percentage point increases in the corporate rate corresponds to about $100 billion over a decade. It would also roll back a big part of former President Donald Trump’s signature legislation in 2017 as president, which slashed the corporate tax rate from 35% to 21%.

Trump, meanwhile, recently said he would cut taxes even further if elected president, including on businesses [to 15%?]. (…)

Republicans are sure to object to a 28% corporate tax rate, meaning Harris may need Democrats to control the House and Senate in order to get it through Congress. But a potential President Harris would have some leverage over the GOP for negotiations on tax policy, as many other portions of the Trump tax cuts expire at the end of 2025, which will lead to a major debate in Congress next year about which parts to extend. (…)

(Polymarket)