April Showers Bring May Flowers

It was a positive end to a volatile week, calling to mind images of “flowers” as we turn the page from April “showers”. Apple’s earnings and record-sized stock buyback plan helped lift sentiment, while the Fed-friendly jobs report and downshift in services activity put a fall rate cut back on the table. After the sizzling March report, both the Fed and markets are breathing a sigh of relief as the April Employment report added to the evidence from other indicators, that hiring is slowing, and the labor market rebalance is already well underway.

The FOMC meeting was not a massive market-mover. As widely expected, policy rates were left unchanged, with the target range at a 23-year high of 5.25%-to-5.50%, which is where it has been since July. There were two major changes in the policy statement. Added in the opening paragraph was the phrase: “In recent months, there has been a lack of further progress toward the Committee's 2 percent inflation objective.” Assuming it’s going to take at least three months of good inflation performance to potentially turn this phrase around, this means the Fed has moved further away from cutting rates any time soon.

Source: BMO Economics EconoFACTS: FOMC Monetary Policy Announcement

The other major change was the announcement on quantitative tightening (QT). The monthly run-off cap for Treasuries was lowered to $25 billion from $60 billion beginning June 1st, with the (non-binding) MBS cap remaining at $35 billion. And when these payments ever get above the cap, they’ll be reinvested in Treasuries. The tapering (of Treasuries) was a bit more than expected, likely reflecting the Fed’s heightened sense of caution as QT gets more fully reflected in reserves reduction.

Source: BMO Economics EconoFACTS: FOMC Monetary Policy Announcement

Despite the changes in the policy statement, financial markets were more relieved by the reassurance that rate hikes were unlikely, and the overall less hawkish tone during Fed Chair Powell’s hour-long conference.

This reassurance was backed up on Friday with April U.S. payroll growth coming in at a much more comfortable 175k jobs after an upwardly revised 315k in March, for once underperforming the consensus which was looking for a more gradual slowdown to 240k jobs. This was coupled with the jobless rate ticking up to 3.9%, and average hourly earnings cooling to the slowest pace in nearly three years at 3.9% y/y. These numbers are right in the sweet spot for the soft-landing scenario the Fed has been hoping for.

Source: BMO Economics EconoFACTS: U.S. Nonfarm Payrolls (April)

The conventional wisdom is that the Fed will be mostly guided by the inflation data (true), and that they can only begin to cut when the trend in core cracks. But, given that Powell sees policy rates as plainly restrictive, and the job market appears to be softening somewhat, some sustained weakness in growth could alone prompt them to begin loosening—provided inflation stops deteriorating. The combination of even so-so inflation results and chillier growth could do the job. Given an unusual paucity of significant U.S. economic reports on deck for next week, we’ll need to wait until mid-May for the next installment in the rate cut saga. It’s unlikely to deliver a clear-cut answer just yet, keeping the Fed in place for another quarter.

Source: BMO Economics Talking Points: How Do You Like Them Apples?

Back across the border, Canadian growth has reverted to form, with GDP in the first two months of the year revised lower and March coming in flat. The dash of reality for Canadian GDP, alongside the milder U.S. job growth, helped reignite prospects for near-term Bank of Canada rate cuts. While Governor Macklem was extraordinarily careful not to tip his timing hand at this week’s dual testimonies, he did allow that rate cuts were getting closer and that the Bank could indeed deviate from the Fed—within limits. Said limits remain a mystery, but we’ll stick with our view that the Bank can likely cut twice independent of the Fed, without causing undue strain on the currency.

Source: BMO Economics Talking Points: How Do You Like Them Apples?

The coming meeting on June 5 is again seen as a very real possibility for the first cut, especially with the Fed potentially back in play in the summer. We have been calling for the BoC’s rate-cutting cycle to begin in June since late last year, and we are doggedly sticking to that call. While we never want to hang a rate decision on a single indicator, the April CPI (on May 21) looms very large. Macklem has already signaled that the Bank expects inflation to stick close to the current 2.9% pace for a few months, due to a pop in gasoline prices (and we readily concur), but all eyes will be on whether core measures stay cool.

Source: BMO Economics Talking Points: How Do You Like Them Apples?

The Bank will also see April jobs (next Friday) and the official Q1 GDP results (May 31) before deciding on rates. But perhaps the second most important indicator tipping the Bank’s decision will be the U.S. CPI (May 15). Even if the BoC can go it alone, it sure would help if it appeared that U.S. cuts would soon follow.

Source: BMO Economics Talking Points: How Do You Like Them Apples?

 

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