The curious case of Canada’s jobs market

The Canadian economy failed to add any jobs in December, with employment levels in full-time positions actually falling by 23.5k on the month. This is consistent with the decline in Q4 growth indicators and the message of weaker labour demand from business surveys.

However, the readthrough of overall economic weakness from December’s labour market data wasn’t completely clear cut. The unemployment rate held steady at 5.8% against expectations of a 0.1pp increase, while wage growth exceeded expectations, climbing from 5.0% to 5.7% YoY. The latter will prove somewhat concerning for the Bank of Canada, especially given November’s uptick in monthly core inflation. While the latest Canadian data poses some interesting questions, our read is that the economy is considerably weaker than both wage growth and inflation data suggest. This is evidenced in today’s labour data, for example. With the population growing by 74k in December, the employment rate fell for the fifth time in six months. The only reason this didn’t translate into a higher unemployment rate, as has been the case since April, is because of a corresponding fall in the participation rate.

However, this is inconsistent with the idea that wage growth is in fact at a multi-decade peak once discounting the pandemic period and a stronger-than-reported levels of inflation, both of which would support an uptick in labour supply. While this could be partially explained by the wealth effects higher population growth is having on house prices, we think it is more symptomatic of a weaker underlying economy.

With job opportunities few and far between, new workers are discouraged from joining the labour market, especially as wage gains are difficult to actually achieve. Falling levels of inflation are also making this less arduous for individuals.

It is in this context that we believe December’s labour market report provides yet another uninspiring data point on the Canadian economy. While markets are likely to focus on the high level of wage growth and the stable unemployment rate as reason to price out expectations of BoC easing, we would caution against this interpretation.

Although we expect it will take a few more rounds of data to show  a more uniform message of Canadian economic weakness, once this occurs we expect the Bank of Canada will quickly turn towards rate cuts. Under our base case we expect the BoC to begin easing in April, cutting the overnight lending rate by 25bps to 4.75%. After which point we expect weak levels of growth, increasing slack within the labour market, and below target near-term rates of inflation will lead the BoC to cut 25bps at every meeting until year-end, bringing the policy rate to 3.5%.

Set against a stronger US economy and a more conservative Fed, we expect a re-widening in rate expectations to send USDCAD back towards its Q4 levels of around 1.38.

Markets continue to trim the possibility of an April rate cut having previously priced a full cut as early as March

Author:

Nick Rees, FX Market Analyst

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