Bank of Canada needs to start cutting rates now: Rosenberg

Article content

The most important inflation metric, the CPIX, which excludes the eight most volatile segments of the index, stands at 2.1 percent year over year. This is pretty well on target, just above the pre-COVID-19 trend and less than half the pace of a year ago.

The year-over-year retail price index has gone from more than two percent a year ago to holding steady today. There is absolutely no pricing power in the Canadian retail sector.

Article content

Article content

Real gross domestic product growth in the past year was 0.9 percent, even with a 3.2 percent year-over-year population increase. The calculations show a drop in real per capita product of two percent at an annual rate.

The unemployment rate, at 6.1 percent, is higher today than before COVID-19, when the policy rate was 1.75 percent, not five percent. That's an increase of a full percentage point year over year, pointing to elevated recession odds of 80 percent. Unemployment figures have risen 23 percent in the past 12 months, as the number of people entering the workforce has nearly doubled the number of people actually getting a job. Nothing here portends a future of accelerated wage inflation: quite the opposite.

Another measure of economic sluggishness, the employment-population ratio, at 61.4 percent, compares with the pre-COVID-19 level of 62.1 percent. Not only that, but the broader form of unemployment that includes all measures of idle labor resources, also known as the R-8 unemployment rate, now stands at 8.8 percent, up from 7.5 percent. from a year ago. That's about the same as the comparable period in 2019 (the data is not seasonally adjusted, so it should be compared to March in previous years for comparative purposes), when the Bank of Canada once again set the interest rate at one day at 1.75 percent.

Article content

Article content

The industry-wide capacity utilization rate (the equivalent employment rate for the business sector) has dropped to 78.7 percent, the lowest (most disinflationary) since the fourth quarter of 2020. The previous level to COVID-19 was close to 80 percent. again, when the policy rate was 325 basis points below where it is today.

Those who are phobic of inflation should recognize that, year after year, due to this excess of supply over demand, producer prices in Canada are -0.5 percent and -0.2 percent for the sector central (excluding the energy sector). index.

The Bank of Canada behind the curve

The Bank of Canada's own estimate of potential non-inflationary growth between now and 2027 is 1.8 per cent at an annual rate. The economy is now running at half that pace. Ergo, the main risk in Canada is local deflation as excess capacity builds up, not inflation.

In the fourth quarter of last year, the disinflationary “output gap” in Canada was estimated at -0.7 per cent and that came after a -0.1 per cent deviation between actual real GDP and the level that would be consistent with inflationary pressure. This is a classic measure of general economic sluggishness. And since then, the “gap” has only widened.

Article content

The Bank of Canada is behind the disinflation curve almost as much as it was behind the inflation curve in 2021 and early 2022. Going back to the last quarter century, an output gap of any size rarely matched a policy rate of five percent. , and on average, the central bank was setting that rate closer to two percent. No matter how it is divided or divided, the Bank of Canada is maintaining too tight a policy. It may be true that the US Federal Reserve is following a different course, but then again, the US economy is running at more than three times the pace of Canada's.

Debt service costs soar

Collectively, Canadians are spending 15 cents of every after-tax dollar on debt service. That's right at the punishing levels that presaged each of the last four recessions dating back to 1990, or longer. The future is one of a cycle of debt deleveraging and defaults, and that, again, is a deflationary development.

The Bank of Canada's estimate of R-star (or the “neutral” nominal policy rate) is between 2.25 per cent and 3.25 per cent. The midpoint, 2.75 percent, means the central bank is 225 basis points “too tight.” Its rate is 175 basis points higher than the upper end of that band, so to speak.

Article content

At the same time, authorities acknowledged at their April 10 policy meeting that “the economy entered oversupply.” In any case, an economy that has entered such a disinflationary “output gap” should have the overnight interest rate. below the midpoint of that R-star range, not 225 basis points above that estimate.

Go long bonds

The message: go long in the Government of Canada bond market, where the largest yield declines will occur at the leading end of the curve and the largest total net returns will occur at the trailing end due to convexity and duration. This should be good news for banks, as well as other rate-sensitive sectors such as pipelines, real estate investment trusts (selectively), and utilities.

And with the Federal Reserve on hold for many months to come, interest rate differentials in favor of the US dollar will keep the Canadian dollar under downward pressure – good news for exporters and tourism operators.

David Rosenberg is founder and president of the independent research firm Rosenberg Research & Associates Inc. To receive more insights and analysis from David Rosenberg, you can sign up for a free one-month trial on the Rosenberg Research website.

Bookmark our website and support our journalism: Don't miss out on the business news you need – add Financialpost.com to your favorites and subscribe to our newsletters here.

Article content